Current bond market trend in Canada sending a signal to go with a variable mortgage rate
If you are in the market for a mortgage loan, then you are probably up to speed with the Bank of Canada’s progressively rising key bank rate. In what the bank describes as heading towards the neutral range, this rate, currently at about 1.75% is expected to grow by another 0.75% – 1.75%. Going by these indices a smart decision for the average mortgage borrower would be to tend towards fixed mortgage rates. Or would it?
- The Bank of Canada is singing a discordant tune
While the BOC’s narrative is no doubt valid, at least from its perspective, the bond market presents a much more incisive view into the Canadian mortgage loan market.
In a quarter predominated by uncharacteristically low interest rates, crisis in the all-important oil sector, a drowning stock market, fear of looming trade wars, slouching consumer spending, a commensurate drop in business investment, and even perhaps more relevant to this discussion a real estate market that is essentially on the backpedal, the nation’s falling 5 year bond yield, a standing compass for Canada’s fixed mortgage rates, paints a better picture of the existing status quo in the real estate market.
- Rates are dropping, and that’s not in the best interests of banks
With these indicators and the more conclusive drop in bond yield (down to 40bps), one would expect a commensurate decrease in 5 year fixed rates. But of course, this is not the case, at least not until banks opt to relinquish their hold on what has been unnecessarily heightened profit margins. If we are to borrow a page from the history books, it is unlikely that this would happen.
A growing backlog of rate hikes and increasingly firmer mortgage rules have all contributed to further stalling the mortgage market. Invariably and without a commensurate drop in the number of competing lenders, there is very little left of the mortgage borrowing cake to go round. This fact is evident in the progressively dipping difference between the going rates of most banks and the Canadian government’s 5-year bond yield. Most banks have opted for a mortgage spread of about 130 to 140 basis points this year as against their preferred 150 plus bps obtainable last year.
More so Canada is very near its economic cycle. In line with the provisions of the current yield curve, most banks will want to charge a higher premium for credit and market risks. Add that to the fact that we are on the verge of experiencing winter, traditionally associated with lower market interest in mortgages and it’s easy to see why they (the banks) will maintain their position to stick with heightened fixed rates – dropping the rates is less likely to activate the market, so why bother.
In sum, expect galloping fixed interest rates until it becomes arduous for banks to pursue that course.
- Variable rates are, on the other hand, tipped to remain relevant.
Thanks to a forecast that obliterates the threat of a rate hike till the spring of next year, variable rates might very well turn out to be the perfect Christmas gift for the fit borrower. And while you might be inclined to assume that the BOC’s rate hikes would threaten variable rates, prevailing circumstances nullify this threat. In fact, per current market pointers, credit, margin and risk concerns pose a more significant threat of affecting variable rates and accompanying discounts than the BOC’s rate hikes. If the former factors eventually affected variable rates/discounts the impact would be borne only by new borrowers. Existing variable rate borrowers get a pass.
The writing on the wall clearly puts variable mortgage rates on the ascendancy in the current market. Considering how low the market set variable mortgage rates are currently, they present too much of a financial advantage not to be considered.
As things stand, fit borrowers can access variable mortgages with a 2.80% rate for mortgages insured by default, or with a 3.35% rate in the case where they are procured for refinancing another mortgage loan.
Compare that to current fixed rates, and you can see that variable mortgage rates are at least 3 rate hikes ahead of traditional 5-year fixed rates. Remember the next rate hike (for variable mortgage loans) is not expected until spring.
Informed borrowers are already exploiting the trend, with the Canada Mortgage and Housing Corporation recently reporting a record number of insured borrowers opting for variable mortgage rates. Right now the positives of variable rates far outweigh the negatives. If this trend continues, expect variable rate mortgages to supersede their much more loved twin once again.