Canada

Free Money? Canadian Mortgage Interest Is Now Less Than The Rate of Inflation

Canadian mortgage rates are so low, how could you not buy a little more house? The rate of interest for a mortgage in Canada recently fell below the rate of inflation. This rarely happens, and the last time real mortgage rates were this negative was over 40 years ago. That was in the middle of an inflation crisis, where everyone bought property to hedge. It produced a bubble, which violently popped shortly after. Though that was then, and this is now. Let’s look at these wildly inefficient market numbers.

Real Mortgage Interest Rates

Real mortgage interest is the rate of interest paid, minus the annual rate of inflation. Mortgage debt with a 2% interest rate in an environment where inflation is 2% is a real rate of 0%. If inflation holds steady the lender is giving you money, returned with no real profit. They can buy the exact same amount of goods when they’re paid as they can before they lent the money. It’s essentially a free loan. Generous people, eh?

It doesn’t happen very often, but it’s happening right now in Canada.

Real Mortgage Interest Rates Haven’t Been This Low Since The 1970s

Canadian mortgage debt is being lent out at less than the current rate of inflation. Generally, the most popular type of mortgage is the 5-year fixed rate term, so let’s peep that. The posted 5-year fixed rate was 4.79% in June, working out to 1.7% after inflation. That’s still a positive number, and would be a big profit margin. Healthy and booming market, right? Just one problem — no one pays the posted mortgage rate.  

Most analysis is done on the posted 5-year fixed rate, which is often used to set policy. Lenders rarely charge that rate, and its primary use is to calculate penalties. The best available rate is typically 220 to 250 bps lower than the posted rate. A 5-year fixed rate actually looks more like the prime lending rate, often a few points lower. So let’s look at the prime lending rate now to get a better perspective.

The prime lending rate for mortgages is much lower than the posted rate. It was 2.45% in June, which is 234 bps lower than the posted 5-year fixed rate. When adjusted for inflation, the real rate is -0.6% for June. A small improvement over the -1.2% seen in May, but still — it’s a negative number. A fairly big one when we’re talking about billions of dollars as well. They’re lending for cheaper than the current rate of inflation.

Canadian Medium-Term Mortgage Rate

The Canadian prime mortgage rate, which closely resembles the typical 5-year fixed mortgage rate. In both nominal and real (inflation-adjusted) values.

Source: Bank of Canada; Better Dwelling.

Canada hasn’t seen this kind of deep discount in generations. The -1.2% real rate is the lowest seen since the late 1970s, when there was an inflation crisis. This led to everyone buying homes at massive premiums as “inflation hedges.” That created a bubble, which popped in the early 1980s, and many tears were shed. A mispriced asset is often repriced to a more fair value once the reason for the mispricing ends.

Canadian Mortgage Debt With Little Rate Protection Is Soaring

Low interest rates have pushed more conventional mortgage dollar volumes to variable rates. Long-term variable rate data isn’t available, but 1-year fixed rate data is pretty close. It is just 5 bps apart from the 3-year variable term, so they’ll give us a pretty close view.

Conventional mortgages with a 1-year fixed rate of interest came in at 2.79% this past June. After adjusting for inflation, the rate is -0.3% in real terms. Short-term mortgages in Canada have never been this cheap. Like, ever.

Canadian Short-Term Mortgage Rate

The Canadian 1-year fixed mortgage rate at nominal and real (inflation-adjusted) values.

Source: Bank of Canada; Better Dwelling.

Does This Mean I Should Borrow As Much As I Can?

I know, you’re wondering if that means you should blow your brains out with debt right now. If you’re renewing your mortgage, ask your mortgage broker — it might be like you just won the lottery. If you’re buying property, the answer isn’t so clear and it’s kind of a gamble. 

In normal circumstances, the assumption is inflation will be stable over time. That’s not what central banks are saying. In fact, they are outright saying inflation will not be this high. A negative real rate today may not be one next year. In this case, the lenders are likely banking on a drop in inflation. This would allow them to support lending lower than the current rate.

The term length is also something else to consider. In the US, with the world’s most liquid currency, mortgage rates can be guaranteed for the life of the mortgage. No surprises if inflation gets out of control, and the state needs to stop suppressing rates. You already agreed for 30 years what you’ll pay. 

In Canada, you’re paying a hefty premium for anything longer than 5 years. That leaves most playing rate roulette on the balance of their mortgage on renewal. Defaulting isn’t so much of a concern since these borrowers will be stress tested. However, appreciation of the home is likely to slow (or correct) in the event of higher rates.

What does this tell us? It shows evidence of the housing market’s massive inefficiency, right down to financing. The real rate of interest is below zero, as if they needed to stimulate more borrowing. This is during a multi-decade high for credit growth… while home sales are just under the record high, and prices are growing at the fastest rate in history.

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11 Comments

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  • Jamie Price 4 months ago

    Everyone wondering, “what fool lends money for less than the rate of inflation?”

    Taxpayers. The Bank of Canada is scooping up almost all of the government debt issuance, and a lot of these terrible bonds to pay for mortgages. Crowding out institutions to drive down rates so they can secure cheap long-term debt, while you can’t secure the same long-run refinancing as them.

  • David Chan 4 months ago

    Now do insured rates, where the government is securitizing debt to the point its real cost more than -2%. That’s if you’re buying into these inflation numbers too.

    • Charles Ponzi 4 months ago

      and insured rates would never be so far below market rates (and affordable housing would be so inflated) if taxpayers weren’t backing it.

  • Charlie 4 months ago

    It is a ridiculous display of disruptive actions in the credit markets. This is just as disruptive and most likely more destructive than anything emanating from the populist or nativist movements recently alarming most on the left. You simply cannot lend for negative returns without creating a massive hole in the longer-term balance sheet. It only works as an illusion and the results will be devastating. In short, we need an adult in the room when government policy is next formulated for using real estate to prop up our GDP. It is as foolhardy as you borrowing against your credit cards to buy any depreciating asset such as a car (in normal times as they are spiking now). Like a casino, the house always wins and the average consumer will pay a heavy price to ensure the banks win.

    • BC Renter 4 months ago

      So Charlie, what’s a simple home buyer to do?
      Overbid on already ridiculously inflated valuations?
      Intrinsic value should be something reflecting average incomes and household formations.
      Should it not?

  • Mortgage Guy 4 months ago

    Only reason people can accept buying negative rate condos. It becomes a problem if they have to sell into a market where the person they’re selling to doesn’t have access to such cheap liquidity, but that’s a different story.

  • LM 4 months ago

    As an example, the composite MLS Home Price Index in Greater Toronto in January 2010 was $393,800. By January 2020, the price had skyrocketed to $836,800 — an increase of about 112 per cent.

    By comparison, the S&P 500 was at 1,115 on January 1, 2010. By January 1, 2020, it had risen to 3,231. That is an increase of about 190 per cent for U.S. stocks. Canadian stocks, as measured by the TSX Composite, rose by about 45 per cent during the same period.

  • LM 4 months ago

    Stock can be kept without any additional expenses like: property tax, land transfers, real estate agent fees, repair expenses and so on.

  • Holton 4 months ago

    Guys, I told you so. We will not crash the housing market. We will simply inflate our way out of this mess.

    • Alex 4 months ago

      That is not how inflation works, mate.

      Real income(how much goods you can actually buy with your income) never goes up in inflationary environments, which is what you are suggesting. What happens is dollar value declines, prices for goods adjust upwards, and then wages adjust as a reactionary measure as living expenses increase. What arises as a result is a feedback loop of dollar devaluation > rising prices > upwards wage adjustment > increase in nominal monetary base > rinse and repeat.

      Inflation, amongst other things, completely erodes not only the value of a currency but the trust in the governing agency of that currency. If lenders knew that centrals banks in tandem with their governments would just rack up tons of debt, then give debtors a free pass via inflating that debt into nothingness, why would I be willing to lend to that institution without a huge premium to compensate for that risk? This is the nature of interest rates.

      It amazes me that people think by tacking another 0 on the end of a note you can solve all your countries economic problems. Its like the past 2000 years of recorded economic history means nothing.

  • Ed 4 months ago

    As an American i’m an outsider looking in, and it is scary. I took a trip to Niagara Falls and Toronto in summer of 2019 right before Covid hit, and I like checking local real estate market prices. At the time I could not understand why home prices were so high in Canada, and I also remember watching HGTV and other “reality” shows and I see couples looking for starter homes reaching close to a million dollars. I thought in Canada they did 40 & 50 year mortgages, but I did not know you mostly did 5 year fixed interest rates. Similarly, in metro NYC, there is a new phenomenon where some home buyers come and outbid others because they get loans backed by Asian banks amortized for 50 and up to 80 years, so their payment is much lower and they can afford to outbid others.

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