Mortgage Report

August 2021 Mortgage Rate Outlook

Rates in the bond market took a downturn in July. Seemingly overnight, investors' anxiety over inflation morphed into worries about an economic slowdown.

But despite falling yields, market expectations for the first Bank of Canada rate hike haven't changed all that much. We're still looking at mid-next year for that, say economists.

What has changed is market expectations of how high rates could go when the Bank is finished tightening monetary policy.

"...Markets no longer expect the BoC to breach the peak rate seen in the 2017/18 tightening cycle," said CIBC Capital Markets last week. The "terminal" rate for Canada is now expected to be about 1.75%, or 1.50 percentage points higher than today.

"Similarly, markets now see the Fed topping-out nearly four [25-bps] hikes below the peak in their prior cycle, which ended in 2019."

Here's more of what the market expects...

Rate Projections

The predictions that follow are based on Bank of Canada forecasts and implied (future or forward) rates in the bond market. Take them with a pinch of salt, as implied market forecasts are forever subject to change.

• Bank of Canada forecast:
  • The first BoC rate increase is still pencilled in for the second half of 2022
  • Source: Bank of Canada
• Consensus economist forecast:
  • No overnight rate (and prime rate) hikes until the third or fourth quarter of 2022
  • Bond yields to increase about 0.22 percentage points through year-end 2021
  • Source: Bloomberg, economist forecasts
• 5-year fixed rate in five years:
  • 2.96%, which represents today's best nationally available uninsured 5-year fixed rate plus the projected increase in Canada's 5-year yield by 2026
  • Source: RATESDOTCA, Bloomberg forward rates
• Estimated long-term "neutral" rate:
  • "Neutral" refers to where the BoC and investors believe the overnight rate will land long-term
  • The number is:
    • 2.25%, according to the Bank of Canada (i.e., two points higher than today)
    • 1.75%, according to bond market-implied pricing, as reported by Bloomberg (i.e., 1.5 points higher than today)
  • That implies that prime rate will top out somewhere near 4.45% in the next five years or so (it's at 2.45% today)

Value Zone

The 5-year fixed (insured, insurable or uninsured)

• Reason: Lower yields notwithstanding, there's no justification to abandon the safe play and lock in. That is, for risk-averse borrowers who plan to remain in their homes for five years.
• Beware: Fixed rates often have brutal prepayment charges, especially if it's a major bank mortgage. RATESDOTCA surveys find that nearly half (47%) of 5-year fixed-rate borrowers renegotiate or refinance before maturity. Hence, you never want to overlook prepayment policies just to save a few basis points on your mortgage rate.

The 3-year variable (insured)

• Reason: With falling rate-hike expectations, intelliMortgage's record-low 0.95% effective rate is looking better and better. It's still the lowest rate in Canada (ever). With a cheap 3-months' interest charge for early termination, a shorter contractual term and the ability to lock into a discounted 5-year fixed rate anytime without penalty, it's a mortgage with flexibility. (Note: We don't usually recommend people convert into a fixed rate before maturity, but it's an option.)
• Beware: Canada is facing some of the most elevated inflation in decades. That's not conducive to rates remaining near their "effective lower bound," as the BoC likes to call it. Rates will head higher and this 0.95% rate won't last when they do. But with a 0.59-percentage-point upfront rate advantage versus a comparable 5-year fixed, you get a decent head start.

The 5-year hybrid (insured, insurable or uninsured)

• Reason: With so much uncertainty over how high rates might go, a hybrid mortgage diversifies your rate risk.
• Beware: You get a mortgage that's half fixed and half variable, leaving you with meaningfully less interest rate exposure. But being half right on rates also means you're guaranteed to be half wrong.

Glossary: Insured: A mortgage that has customer-paid default insurance (typically purchases with less than a 20% down payment); Insurable: A mortgage that has lender-paid default insurance and 20% equity or more; Uninsured: A mortgage without default insurance (this includes all refinances, all amortizations over 25 years, purchases of properties over $1 million, non-owner-occupied rental properties and other mortgages not meeting default-insurance rules).

Reader note: The generalized guidance above doesn't apply to all because everyone's circumstances are different. It's a good idea to consult a mortgage professional for advice focused on your personal finances, goals and five-year plan.

Future Rate Expectations