The Bank of Canada adopted a decidedly positive tone Wednesday when it left the country’s key lending rate untouched at 0.25%.
Despite the Bank’s optimism that the worst of COVID’s economic impacts have passed, recoveries take many months. Most economists don’t predict the Bank will start hiking rates again until 2022.
“Decisive and targeted fiscal actions, combined with lower interest rates, are buffering the impact of the shutdown on disposable income and helping to lay the foundation for economic recovery,” the Bank said in its accompanying statement.
Despite the economy getting pummelled by job losses in April, “this impact appears to have peaked,” the Bank added, “although uncertainty about how the recovery will unfold remains high.”
Indeed, there are emerging signs of economic strength. Early May data from local real estate boards currently show an increase in home sales ranging from 30% to almost 70%.
However, few economists expect a sharp “V-shaped” recovery, as additional waves of COVID-19 outbreaks and long-term unemployment could slow the economy’s full recovery.
That makes long-term low rates a safe bet — at least according to TD Economics. It says rates will remain at/near 0% until at least mid-2022. Many other economists agree.
“We will be recovering into recessionary territory (of ~8%+ unemployment),” notes CIBC’s Ben Tal. That’s bearish for interest rates, all else equal.
With fixed mortgage rates declining by the week, and variable-rate discounts slowly improving, what’s a prospective borrower to choose?
While variable rates aren’t likely to benefit from a drop in prime rate (which technically could occur if the Bank of Canada cut interest rates to 0% or below), variable discounts from prime rate are slowly growing.
HSBC was the latest big bank to cut its variable rates, which are now at prime – 0.60% (1.85%), the lowest nationally available variable rate in the country. It’s still off from the prime – 1.00% rates we saw prior to COVID, but we’re getting there.
Meanwhile, fixed rates are now starting to break the 2.00% barrier, albeit mostly default-insured shorter-terms, like 3-year fixed rates. Insured 5-year fixed rates are knocking at the door, currently just above 2.00%.
The most common mortgage decision is variable vs. fixed. So let’s analyze which is better with a quick example. Assume a 5-year variable rate of 1.95% compared against a 5-year fixed rate of 2.49%.
Even with three Bank of Canada rate increases over the next five years, with the first taking place in the fall of 2021, the variable rate would still come out ahead—just barely, however, with a savings of $15 per $100,000 of mortgage.
Keep in mind, three rate hikes is what the Bank of Canada delivered in the aftermath of the 2008-09 financial crisis. So it’s plausible. Monetary stimulus takes almost two years to work through the economy.
Should the Bank hike more than three times, then other things equal, a fixed rate of 2.49% would be crowned the winner vs. a prime – 0.50 variable rate.
That’s based on interest cost alone. It doesn’t factor in prepayment savings should you need to break your mortgage early. A variable rate broken early costs you three months worth of interest, while fixed rates use a more complicated Interest Rate Differential calculation. In the case of this Ontario mother, that worked out to a painful $30,000.
If there’s a decent chance you’ll need to break your mortgage before 2025, a variable rate mortgage would win hands down.