- 70s-style rate increases? 2021 will go down as a year of fiscal expansion, loose monetary policy and exploding commodity prices. That’s drawing comparisons to the 1970s, when inflation averaged 8%. Today, if core inflation even topped 3% it could more than double the deliriously low mortgage rates we enjoy today. But Capital Economics says that today’s inflation control, technology, competition and offshoring practices don’t make the 70s a good comparison. On the other hand, it adds that businesses are now expecting well over 3% price hikes in the next year. In other words, inflation outlooks may be getting unanchored from the BoC's 2% target. That is one of the greatest risks to low rates because inflation expectations can become self-fulfilling. As we’ve been writing for months, mortgagors face more risk of inflation (read, higher rates) in the next five years than they have in well over a decade.
- Could people cope? If rates surged two percentage points, the average mortgage payment (assuming no refinancing) would leap 20%. If your income rises 2.5% a year, that means you’d earn about 13% more by the time you renew a 5-year term — compared to what you made when you got the mortgage. On an absolute basis, however, your take-home pay would still grow more than your mortgage payment, not including inflation of other goods. It’s when mortgage rate increases top three percentage points that the wheels really come off. At that point, average income gains can’t keep up with mortgage payments and living expenses. (There are lots of assumptions here, so consider this just a rule of thumb.)
- The new risk/reward debate: Floating rates present risk, but this week’s new high-ratio 0.95% 3-year variable rate spells reward, at least for the next one to two years. Over that span it’ll save borrowers dramatically more interest than most fixed rates. It's what happens thereafter that should worry most.
- Real estate nail-biting: Housing keeners eagerly await price and sales data from Toronto and Vancouver next week. National home sales obliterated records last month — 22,000+ units more than the prior record. Volume is something to watch because after a big run-up, when that many of anything change hands (relative to what's normal), it risks signifying a blow-off top. Extreme volume and price spikes combined, ultimately lead to price reversals most of the time.
- Non-prime money stays cheap: Despite surging 5-year rates, most GIC and savings rates are flat or even down year-to-date. That’s partly because of demand. Deposits have skyrocketed during the pandemic. This phenomenon is holding down lenders’ short-term funding costs. That helps lenders, particularly non-prime lenders, offer better 1- and 2-year fixed rates.
Rates are based on a $300,000 mortgage.
6. Tight spreads: The difference between lenders' best discounted rates and 5-year fixed funding costs is near a long-term low. That means when bond yields shoot up next, it will likely take less time for the big banks to ratchet up fixed rates.
7. Yields flat for a reason: Bond yields lead mortgage rates, and yields are showing resilience in the face of the third wave’s coming hit to GDP. The market knows that vaccinations are happening fast and furious with almost 40% of adults receiving at least one dose. As summer approaches, people will spend more money (potentially much more). Once the market starts re-anticipating that, rates should levitate further.
8. Back to 2007: A large non-federally regulated lender has launched a new “Declared Income” mortgage. It reminds us of the “old days” (2007) when equity mortgages were a thing at institutional lenders. To get this mortgage, you basically tell the lender how much you make. There’s no proof of income, the lender lets you qualify based on your actual interest rate (i.e., there’s no “stress test”) and you can get a 40-year amortization. The product is designed for the self-employed, contractors and others who have huge write-offs or don’t report all their income in a traditional manner. You need to prove self-employment and must have 35%+ equity. The price for this flexibility is rates in the mid-to-high 6% range, plus fees. Contact a mortgage broker for more info.
9. How far to neutral?: The Bank of Canada projects that its key lending rate will eventually level off at roughly 2.25%, +/- 0.50%. That’s two percentage points higher than today. Not so coincidentally, markets are projecting a roughly 2.40% “terminal rate.” This neutral (or terminal) rate refers to the rate that neither stimulates nor suppresses economic growth. Bond traders are betting that the next rate peak will be higher than prior rate-hike cycles. That's likely because this recovery has far more government support, supply bottlenecks, commodity inflation, consumer savings and other Covid peculiarities.
10. Not enough houses: If you’re waiting for new supply to cool housing, here’s some good news. “…Homes under construction to population growth is at a record high,” says Capital Economics. The bad news is, most people want houses and “90% of the rise in the past year has been due to higher condo construction.”
