Ask many economists and they’ll tell you mortgage rates – both fixed and variable – are likely coming down in 2023.
Ask the Bank of Canada and it would probably say, “Don’t get too optimistic.” Year-over-year inflation is still “way too high,” Tiff Macklem, the bank’s Governor, warned this week, and the latest inflation report shows it coming down too slowly.
The Bank of Canada is likely not even remotely contemplating rate cuts, despite the bond market fully pricing in two cuts of 25 basis points each within 12 months. (A basis point is one-hundredth of a percentage point.)
So, what if the Bank of Canada is right and the bond market is wrong? Could borrowers hold out at today’s rates, which remain near 14-year highs?
Borrower liquidity is key
Recession notwithstanding, it’s possible that rates could get stuck near today’s levels – for much longer than we think. Or worse, rates could surprise the market and climb to new highs – just like they surprised the world in 1979.
What would cause that? Well, anything from another oil price shock to sticky wage inflation from persistent labour tightness, to a Russian-Ukraine escalation, to another COVID outbreak.
Such scenarios could readily drive rates another 100 to 200 bps higher, taking prime rate from 6.45 per cent today into the sevens or eights.
That would cause a financial meltdown for a meaningful minority, given more than half of Canadian mortgages are either fixed rates coming up for renewal in 2023, or variable.
Even without another 100 to 200 bps of tightening, those renewing five-year fixed terms now face rates that are roughly 175 bps higher than in 2018.
It’s even worse if you’re a rate floater. A year ago, the average new mortgage was $358,717, according to Canada Mortgage and Housing Corp. With 400 bps of rate hikes in 2022, variable interest expense on that amount has risen $14,000 a year in just 10 months.
In terms of payments, 2021′s average new adjustable-rate borrower was hit with a $754 increase to monthly payments this year. Not easy to swallow when the average Canadian has just $654 of disposal income left over each month, according to a recent survey by MNP Ltd., an insolvency practice.
Tack another surprise 100 bps of rate hikes on that and payments would jump an additional 10 per cent, on average.
Most borrowers can tolerate this pain for a while, given the median Canadian had $10,700 of liquid assets in 2021. But surveys show that roughly one in four live on the edge with little financial safety net. Payment increases on the order of $700-plus a month will tap them out in 2023, forcing many to borrow off revolving credit to pay their mortgage, get a second job, get a renter, or sell – some against their will. That latter option is why the housing market bottom many are forecasting for 2023 is no sure thing, particularly as job losses mount.
In the late 1970s experience, Consumer Price Index inflation increased by 2.3 times (from 5.6 per cent to 12.9 per cent). Prime rate had to rise almost 2.8 times to crush it.
This time, inflation momentum is proportionately more extreme. CPI rocketed to more than four times its 2-per-cent target last June. And it did so in just 16 months.
So far, rates are up 2.6 times since March. Is that enough cold water to extinguish inflation’s fire? The one in four on the edge sure hope so.
I don’t want to leave you thinking the housing market won’t survive the monetary tightening to date. It can and it will. But if there’s a Round 2 to the Bank of Canada’s war on inflation, then, to paraphrase Queen Gorgo from the movie 300, this will not be over quickly – we will not enjoy this.
Christmas ‘rate sale’ in progress
All right, it’s not exactly a fire sale, but we are indeed getting some Yuletide rate relief.
Since the peak one month ago, the lowest nationally advertised five-year fixed has dropped 30 bps to 5.14 per cent (uninsured). On a standard mortgage, that saves $1,445 of interest over five years, per $100,000 borrowed.
Compared with the lowest uninsured variable at 5.90 per cent, a 5.14 per cent five-year fixed might not seem so bad. But it’s literally the fourth-worst term you could take if you’re well qualified and risk tolerant.
The worst, second-worst and third-worst terms are the 10-year, seven-year and six-year fixed, respectively. That’s true for two reasons. For one, history shows they perform miserably after mortgage rates shoot this much above their long-term average – relative to shorter and variable terms, that is. For another, owing to how fixed-rate prepayment charges are calculated, any fixed term over five years usually entails considerable penalty risk.
The closer we get to recession; the more fixed rates will drop. But don’t be surprised if we see another rate pop before that happens. Temporary reinflation remains a risk – one the Bank of Canada would react “aggressively” to, according to Mr. Macklem. While I don’t expect it, the market is notorious for disappointing borrowers – right when they think they’re out of the woods.
Rates in the accompanying table are as of Thursday from providers that advertise rates online and lend in at least nine provinces. Insured rates apply to those buying with less than a 20-per-cent down payment, or those switching a pre-existing insured mortgage to a new lender. Uninsured rates apply to refinances and purchases over $1-million and may include applicable lender rate premiums. For providers whose rates vary by province, their highest rate is shown.