Canada

Canadian Interest Rates Are Falling, But Fear Is Driving Mortgage Rates Higher

Are falling interest rates going to push Canadian real estate prices even higher? That’s not exactly what’s happening right now. The Bank of Canada (BoC) has been rapidly lowering the overnight target for interest rates in response to COVID-19 economic slowdowns. Concerns about this overheating the market are starting to bubble up (no pun intended). However, so far the cuts haven’t translated into savings for many new mortgages. In fact, there’s already been a few cases where mortgage products have been rising in response to the cuts. Here’s what to watch for.

Conventional Rate Wisdom

The BoC’s overnight target rate is fairly straightforward in normal markets. The target rate influences interest major banks charge amongst themselves, for overnight lending. Changes to this rate are almost immediately passed on to variable mortgage rates, which are tied to overnight rates. Less obvious is, this also indirectly impacts new fixed mortgage financing and refinancing. It does so by influencing bond yields.

Fixed mortgage rates, the most popular form of mortgage, is tied to the yield of bonds. Raising interest rates drives bonds lower, increasing yields. This generally raises the rate of fixed mortgages, to be competitive. Lowering interest rates drives bonds higher – causing yields (and generally fixed) rates to fall.

It’s straight-forward logic, and this is what you’re probably hearing from more savvy agents. Lowering the overnight yield will generally translate to more favorable financing terms. More favorable financing typically means more sales, and often higher prices… except in times of crisis.

So What Does Happen In Times Of Crisis?

In times of crisis, central banks often drop rates to help mitigate losses. Economic crises involve layoffs and higher debt usage, as well as other bad news for lenders. Banks, which hate risk, now have to worry about a rise in credit and defaults. This can result in lenders not handing down rate cuts, by either not dropping the prime rate, or reducing the discount on the prime rate. When you see a divergence between interest rates, and the rate offered – you know banks are worried about their money.

Think about it for a second. How likely are you to lend cash to someone for less than the rate of inflation? Now how likely are you to do that with someone where the future of their job isn’t exactly clear? You’re probably not super thrilled about it. This is something we’ve seen recently in Australia, where banks refused to pass on savings – before COVID-19. As risk climbs, so does the need for incentive to participate in that risk.

Posted rates have been dropping, but that’s not the rate most people pay. Many mortgage products are actually climbing, according to sites like Rate Spy. On March 18 (two days ago), RBC increased its 5 year fixed from 2.94% to 3.34%. TD similarly boosted its 5-year variable from 2.85% to 2.95% yesterday. Divergences like this are often a warning sign to the market.

Canadian interest rates are low, and are very likely to head lower in the future. It’s not clear if this will translate to lower mortgage rates though. As risk and liquidity concerns surface, banks are likely to lower the discount on the posted, or not pass on cuts. If they do pass on cuts in a deteriorating economic environment, it would most likely be in a situation where mortgage lending has slowed.

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16 Comments

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  • OM 5 months ago

    500,000 unemployment claims this week! More than 10x what they were expecting. Forget buying a house. People are probably more worried about keeping the place they’re in.

  • Trader Jim 5 months ago

    Thanks for Ron Butler’s feed. Lots of gold.

    Especially this on how 6 month deferrals aren’t what people think they are. This is really not going to be pretty.

    https://twitter.com/ronmortgageguy/status/1240882505135333377?s=20

  • Stetson Fortesque 5 months ago

    People are staying home more and their personal space and creature comfort has become increasingly valuable. So they put off buying a new car and instead, splurge on a bigger house or condo. I agree with other posters that commercial real estate may well take a hit in this crisis, but residential properties will be prized like precious gemstones, or a mouthful of foie gras.

    • Kamal 5 months ago

      lol. What a dumb comment. Yeah, it’s going to be exactly like foie gras – no one wants to touch it but boomers, the thought negative cap condos were a good idea.

      REBGV sent this out this morning, asking agents to stop showing homes.

      https://www.rebgv.org/news-archive/real-estate-board-strongly-recommends-realtors–refrain-from-hos.html.html

      Precious gemstone. lol. Some people really are idiots.

    • LoL 5 months ago

      Yea, ok.
      Good sales pitch

    • Canaduh 5 months ago

      This must be a joke.
      No one could be so stupid.
      Best of luck to you.

    • carlton 5 months ago

      “but residential properties will be prized like precious gemstones, or a mouthful of foie gras.”

      LOL,

      The most ridiculous statement I’ve ever read in my life. We will see how these overvalued, overpriced, precious gem stones hold up during this recession.

      You didn’t hear? bulls have all gone home, Its bear season!

      I’m a home owner too, but sometimes you just have to face reality………….. crash!

    • SH 5 months ago

      Principal residences may be prized. But not investment condos. Those will be sold off like penny mining stocks and take the value of the PRs with them. Don’t forget that the majority of condos in Toronto and Vancouver in recent years were sold to speculators, not people looking for a home themselves.

      • Neo 5 months ago

        Bingo! The delevaging has already started. People will sell their principal home last but sell the investment properties they levered with their principal home equity without batting an eyelash out of self preservation. That alone will flood the market and lower prices. Shake out the weak hands.

  • Fraser 5 months ago

    all markets down globally, its just a matter of time before before houses start to crash as well…

  • RobertW 5 months ago

    Massive consumer debt load combined with under-employment and shrinking net wages were ubiquitous prior to this pandemic.

    Mortgage lenders recognize they’re facing growing risk and as a result, interest rates will likely climb proportionate to this risk.

    The risk lenders face will be exasperated by the COVID CRISIS, not mitigated by it.

  • DB 5 months ago

    if you call a chunk of coal precious and that foie grass thing…it’s all good unless there is goose poop it..which this one will have. lol

  • M.Bury 5 months ago

    We are beginning to witness that early is NOT the same as wrong.

  • straw walker 5 months ago

    A banks point of view. Would a bank lend out money at these rates??
    If the Wuhan virus is over in 3 months rates will move higher and banks will be stuck with mortgages with near zero rater.
    If the Wuhan virus lasts for 3 years the unemployed levels will reach highs that will not even zero mortgage rates will save then..which will contribute to lower real estate values..
    Banks have no choice but to raise rates…not lower them

  • Investor 5 months ago

    I’m very afraid to make a move that will force me to touch these bloated real estate. My wife, not so much – to her, I’ve turned into a pessimist who chooses to miss out on opportunities. Even if COVID-19 doesn’t correct this bloat, it’s just a matter of time; I’m sure of that, but I have no idea when.

    • Carlton 5 months ago

      If she can pay for it by herself, let her go ahead. If she can’t …….. then wait together and see how it is in 6 months.

      Will you both be employed then? ..,,,,,,,,, at this point, it can’t hurt to be cautious.

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