Why five-year variable rates will likely save money versus their fixed-rate equivalents in 2022 (and beyond).
We begin 2022 with Canadian inflation at its highest level since 2003.
Prices have been driven higher by a combination of surging demand, fueled by generous government support payments, and supply shortages tied to the pandemic.
Both the Bank of Canada (BoC) and the US Federal Reserve have been predicting that these factors will have only a transitory impact on inflation.
The term transitory means “non-permanent”, which still appears to be the correct assessment, but it also means “of brief duration”, which hasn’t been the case.
The experience of hotter and stickier inflation has caused both bond-market investors and the wider public to lose confidence in our central bankers.
That is concerning because if people lose faith in their ability to keep inflation contained, they may start accelerating their purchase plans to avoid future price increases, and any such additional increase in demand would push prices still higher. The longer inflation persists, the more likely it becomes that workers will push for higher wages to compensate for their reduced purchasing power. This engenders a self-reinforcing cycle, where the fear of higher inflation causes it to materialize.
With public confidence waning, both the BoC and the Fed had no choice but to stop using the term transitory and to turn more hawkish on monetary-policy tightening. At this point, higher mortgage rates in 2022 appear all but inevitable. But how high will they go?
The five-year Government of Canada (GoC) bond yield, which our five-year fixed mortgage rates are priced on, has already surged higher in anticipation of five quarter-point BoC rate hikes in 2022 and two more in 2023. Those are some big moves that are already priced into five-year fixed rates if you lock in today.
Meanwhile, for at least a little while longer, the BoC’s policy rate stands at 0.25%, and that means five-year variable mortgage rates are still available in in the low 1% range, or about 1.25% below their fixed-rate equivalents. That is a much larger buffer than normal.
The futures market is expecting that spread to disappear by the end of the year, but I am skeptical for the following five reasons:
- Omicron’s Impact Is Being Underestimated
In their initial assessment of the Omicron variant, policy makers assumed that its economic impacts would, like its typical symptoms for the vaccinated, be relatively minor.
The Fed initially predicted that Omicron would exacerbate supply shortages and put more pressure on inflation over the short term, but thus far, Fed Chair Powell has said that Omicron will not have much impact on its plans.
I predicted (here) when he made that statement in December that he would regret it, and if he doesn’t already, I expect he will soon. While Omicron’s typical medical impact on the vaccinated has been minor compared to previous COVID variants, it has still caused hospitalizations to spike and is proving quite severe in the unvaccinated.
US vaccination rates and public safety measures have lagged those in Canada and most other developed countries, and that makes the country much more vulnerable to Omicron. If lockdowns are sworn off and US vaccination rates continue to lag, US hospitals may be overrun. That rising risk increases the likelihood that US economic momentum will slow and that the Fed will turn more dovish.
The approach of most Canadian provinces to Omicron has been more cautious. We have closed schools and reinstituted other lockdown restrictions to try to slow infection rates and keep our health-care system from becoming overwhelmed. That reduces our risk of health harm, but it also increases our risk of economic harm, and that, in turn, should turn the BoC more dovish.
- Inflation Will Cool More Rapidly Than the Market Expects
Our Consumer Price Index (CPI) captures price changes over the most recent twelve months.
Prices started to surge in the second half of 2021, and if inflation is going to maintain its current pace into the second half of 2022, it will take another fresh round of price spikes. This seems increasingly unlikely. Supply constraints are gradually being rectified and Omicron has already made consumers more cautious with their spending.
The consensus expects another demand-fueled price spike when we finally free ourselves from the pandemic’s clutches. The theory goes that consumers will spend the cash that they have built up, and that we will see a repeat of the Roaring 20s, when growth and demand surged after the Spanish flu ended.
I have already rebutted that prediction in previous posts. To summarize, the US population was much younger then, US government and household debt levels relative to GDP were miniscule compared to today, and World War I had devastated Europe’s manufacturing capacity, which made the US the world’s dominant exporter over that decade. Very different times.
But what if I’m wrong and we do see a return to the Roaring 20s? Does it follow that inflation will take off?
If past is prologue, the answer is still a firm no.
The chart below shows what happened to inflation when the Spanish Flu ended (and it went on to average less than 2% over the entire 1920s decade).
- There Will Be Much Less Stimulus in 2022
Our policy makers used record levels of fiscal stimulus to offset the pandemic’s initial economic shock.
Those stimuli created many positive short-term impacts that included elevating our GDP, increasing demand, and driving wage growth higher. But those benefits came with a cost. Both US and Canadian budget deficits have soared, driving our government debt levels still higher into the stratosphere.
In addition to being the main contributor to our economic growth in 2021, massive fiscal stimulus was also the primary driver of today’s demand-induced inflationary pressures. But that powerful stimulus has already been sharply reduced on both sides of the 49th parallel, and our governments simply cannot deploy the same largesse to offset any future shocks caused by the pandemic.
The BoC and the Fed are in the same boat as their respective federal governments. They slashed their policy rates to the floor and used quantitative easing (QE), first to flood financial markets with liquidity and then to push bond yields lower. Those moves stimulated financial markets and helped to avoid a repeat of the Great Depression, but they did so by causing asset values to soar, and thereby raising bubble risks across the economy.
Our central bankers now feel compelled to tighten monetary policy to maintain their inflation credibility and help stave off those bubble risks, but that tightening will likely exacerbate, not alleviate, the pandemic’s negative impacts over the year ahead.
If the aggressive rate cuts that have helped asset values surge higher since 2020 are reversed, asset prices would normally reverse direction as well. If that happens, the wealth effect that caused consumers to spend more last year because they were richer (on paper) would also dissipate and cause consumers to turn more cautious.
- The Impact of Rate Hikes Will Be Magnified
Caught between the devil (inflation expectations becoming unanchored) and the deep blue sea (negative economic shocks tied to the pandemic), the BoC and the Fed are reaffirming their commitments to maintain price stability above all else.
But with much less fiscal stimulus buoying economic activity (and exacerbating inflationary pressures), with Omicron’s impacts proving more substantial than first expected, and with elevated debt levels increasing the overall cost of each rate rise, the impact of each hike will be magnified.
All that makes it likely that fewer hikes will ultimately be required to bring inflationary pressures to heel.
If we see anything close to the five BoC rate hikes the consensus is betting on, I think it will prove to be a misstep that will drive our economy into recession. If that happens, rate cuts would almost certainly follow thereafter.
- Labour Costs Will Be Contained
Despite many anecdotes to the contrary, the hard data show that wages are still largely contained in both Canada and the US, even though our employment backdrops are quite different.
In the US, average wages have risen by 4.7% year over year, but they still haven’t kept pace with overall inflation. By the Fed’s own assessment, average wages were suppressed prior to the pandemic, and some of that increase is therefore a catch up. While US employers are still experiencing labour shortages, US workers are expected to return to the labour force now that emergency benefits have expired and they are burning through their built-up cash reserves.
US wages may continue to rise, but so too should the labour-force participation rate as workers start to re-engage out of necessity.
In Canada, our employment recovery has significantly outpaced our overall economic recovery. That’s good for the hiring data but seriously bad for our productivity levels. We are employing more people to do the same amount of work, and that helps explain why our average wages have only increased by 2.9% on a year-over-year basis and why they remain well below their pre-pandemic level with no signs of any imminent breakout.
Now let’s tie all the above commentary back to the key question of whether fixed or variable mortgage rates will prove cheaper in 2022 and over the next five years.
My crystal ball doesn’t come with any guarantees, but with that said, I fundamentally believe the following:
- Omicron’s greater-than-expected impact will make both the BoC and the Fed more dovish.
- Supply challenges will continue to be overcome in the year ahead, and inflation will subside more quickly than expected.
- Demand will moderate without the powerful tailwind of fiscal stimulus.
- The impact of each rate hike will be magnified, and as such, we will need fewer of them.
- Wage growth will not push inflationary pressures materially higher.
Against that backdrop, I expect that variable mortgage rates will save money over their fixed-rate alternatives over the year ahead, and, true to their usual form, are a good bet to do so over the next five years.
It won’t be as easy for variable-rate borrowers this year, because I do expect some rate hikes to ensue, but the gap of about 1.25% over the available five-year fixed rate alternatives provides a large and significant buffer that I don’t think that will close in 2022 as the consensus predicts.
Meanwhile, GoC bond yields have spiked in anticipation of five BoC rate hikes in the year ahead, with two more the year after, and I expect these rates to move lower if and as it becomes clear that the Bank’s raising schedule will be both more gradual and less severe than the consensus forecast.
The Bottom Line: US bond yields have recently surged higher in response to the release of the Fed’s minutes from its December meeting, which revealed that it may tighten more quickly than previously forecast. GoC bond yields have risen in sympathy.
That said, all the pandemic-related news since then has been worse than expected, and that should soon put an end to the current run up. In the meantime, however, the five-year GoC bond yield has recovered to near its previous high, and if it continues its current trajectory, five-year fixed mortgage rates could move higher over at least the short term.
Five-year variable rate discounts have recently widened a little, and for the reasons outlined above, I don’t expect the BoC to increase at nearly the pace bond-market investors are currently pricing in over the year ahead.
This just in data is when mortgage interest rates are expected to rise.
DATA JUST IN
Canada’s latest employment and inflation numbers have triggered new expectations about the next steps by the Bank of Canada and the arrival of interest rate increases.
BoC Governor Tiff Macklem continues to offer soothing words about inflation, which is current running at 4.1%. That is an 18 year high and more than double the central bank’s 2.0% target.
Macklem has repeatedly said high inflation is temporary; the result of low prices during the pandemic lock-downs, and supply chain problems that have cropped-up as the economy reopens.
Macklem points out that a key factor in long term inflation – wage growth – has not materialized. That is despite Canada returning to pre-pandemic employment levels with the addition of 157,000 jobs in September. It should be noted that the growth of Canada’s labour force during the pandemic means the country is still 276,000 jobs short of full employment. Last week however, Macklem did concede that this temporary inflation may linger for longer than initially expected.
Several prominent economists have weighed-in. Benjamin Tal cautions that inflation is a lagging economic indicator. He says the risks for long-term inflation are present and the Bank of Canada would be better to start raising rates earlier to help mitigate those risks. Doug Porter says there is a growing chance rate increases will come earlier. He expects they will happen quarterly rather than every six months. And, Derek Holt would like to see a rate hike by the end of the year, given that emergency levels of stimulus are in place while inflation is well above target.
Look for mortgage interest rates to start going up close to the end of 2021 and continue until they are back close to PRE-Covid Rates of about 3.35% for the 5-year fixed.
Mortgage Mark Herman, best Calgary mortgage broker for the masses!
A normal English article with predictions of Canadian Mortgage Interest Rate Predictions, September 2021.
We think these rates are going to happen but ON A LONGER TIME RANGE that what they think.
Summary of Expected Rates*
- 2.55% – 2.65% in October, 2021
- 2.60% – 2.85% in December, 2021, reduction in buying power of 7%
- 3.10% – 3.30% in October, 2021, reduction in buying power of 8% – 14%
*These rates can totally happen, and are still lower than Pre-Covid rates, but also consider these things that would delay economic recovery/ keep rates low: Iraq – any thing, a 4th and 5th wave of Covid, new variants, USA droughts/ wild weather.
Mortgage Mark Herman, top Calgary Alberta mortgage broker, for new buyers
And a Renewal Surprise:
You may be surprised by the cost of a renewal. A $500,000 mortgage with a 5-year fixed rate of 2.0% would pay around $46,080 in interest over the term. If that rises to 3.1% next year, the cost of interest over the same period would be $72,183. That is an extra $26,000 if interest a year. ANSWER: look at renewing early. We can help you out with that.
OK … on with the news:
The Canadian economy is improving, excluding some minor hiccups like this morning’s GDP. An improved economy needs less stimulus, and that means higher mortgage rates. To see what Canada is in for, we modeled a forecast range for 5-year fixed-rate mortgages. If Canada doesn’t go into a double-dip recession, much higher mortgage rates are coming.
Canadian 5 Year Fixed-Rate Mortgage Forecast
Today we’re looking at 5-year fixed-rate mortgage interest, and where it’s heading. More specifically, we’ll be focusing on conventional (aka uninsured) mortgage rates. These are for homeowners with a decent amount of equity, and a loan to value ratio below 80%. Insured and variable rate mortgages follow a different path. However, they’ll generally follow the same trend.
This model is based on fixed income forecasts created by major financial institutions. Since they’re forecasting how much investors will make, we can forecast how much you’ll pay. Just a couple of quick notes for the nerds, and aspiring nerds.
The strength of the economy and the recovery are going to be big factors in determining how high these go. A stronger economy means a faster recovery, and along with that is higher mortgage rates. Weaker economic performance will generally mean lower rates to stimulate borrowing. As economic conditions change, so will these forecasts.
Credit liquidity will also play a role in the direction of mortgage rates. If there’s excess capital to lend, mortgage lenders tend to accept smaller margins. This helps to lower the cost of borrowing since they’ll make it up on revenue. If capital for mortgages becomes scarce, mortgage rates rise to adjust to demand.
Today’s chart assumes a medium level of credit liquidity. That is, not much excess, but it’s not scarce either. That’s how the mortgage market was pre-pandemic, and we’ll assume it goes back to that.
Canadian Mortgage Rates Are Going To Climb
Mortgage borrowing costs are likely to reach pre-pandemic levels soon. Our median 5-year fixed-rate forecast is 2.55% by the end of Q3 2021. Based on the most bullish yield forecast, it would rise to 2.65%. The downside yield forecast is the same as the median.
Most institutions have consistent near-term expectations. That sounds weird, but it makes sense. Near-term forecasts are the most visible, with the least number of variables compounding. As forecasts are further out, we’ll see the gap widen as their difference in outlook is magnified.
Canadian 5-Year Fixed Rate Mortgage Forecast
The forecast range for Canadian conventional 5-year fixed-rate mortgages, based on financial institution fixed income forecasts.
Mortgage Interest Rates Can Increase Substantially By Year-End
By the end of this year, we start to really see the potential for these rates to climb. By Q4 2021, the median forecast would put a typical 5-year fixed-rate mortgage at 2.73%. The forecast range becomes wider, going from 2.6% (low) to 2.85% (high). It may not sound like much, but it can have a big impact.
The rate of change is much more important than the actual number. If you go from a 2% rate to a 2.73% rate, your cost of interest rises 36.5%. If we exclude the stress test, buying power sees a 7.84% decline. Since recent buyers are mostly stress-tested, default isn’t much of an issue. However, the cost and size of debt can be.
Mortgages Rates May Rise More Than A Point By Next Year
Next year is going to be a big one for mortgage rates if the economy recovers as expected. The median 5-year fixed-rate forecast works out to 3.10% by the end of Q3 2022, which can lead to an 11.5% reduction in buying power. On the low end, the rate still comes in at 2.7%, reducing buying power by 8.0% outside of a stress test. The high range would see it climb all the way to 3.30%, pulling maximum mortgage credit 14.3% lower. Keep in mind the stress test rate may also adjust higher as well. It depends on how comfortable OSFI is with rates rising closer to their stress test number.
Another factor to consider here is the cost of the renewal. A $500,000 mortgage with a 5-year fixed rate of 2.0% would pay around $46,080 in interest over the term. If that rises to 3.1% next year, the cost of interest over the same period would be $72,183. I don’t know about you, but $26,000 is a decent chunk of money to spend over a year.
Existing mortgage holders close to renewal may want to text their mortgage broker. If you see the economy improving, locking in rates might save you a little money. It might not though, depending on whether you have prepayment penalties. It’s always best to run the numbers with a broker on various scenarios though.
Pending a double-dip recession doesn’t occur, higher mortgage rates are coming. Maybe not as high as the Desjardins forecast, but definitely higher than it is now. Those supersized mortgages with short terms are going to divert more capital from the economy on renewal. The takeaway isn’t how high mortgage rates can climb though. It’s how absurdly cheap mortgage debt has been during the pandemic.
Link to the actual article: https://betterdwelling.com/canadian-mortgage-rates-will-rip-higher-soon-heres-how-high/#_
If you’ve been thinking about buying a house, you’ve probably considered how much you can afford in mortgage payments. Have you also thought about what would happen if you lost your source of income?
While the sudden loss of employment is always a possibility, the current uncertainty of our economy has made more people think about the stability of their income. Whether you’ve already made an offer on a home or you’ve just started looking, here is how job loss could affect your mortgage approval.
What role does employment play in mortgage approval?
In addition to ensuring you earn enough to afford a mortgage payment; mortgage lenders want to see that you have a history of consistent income and are likely to in the future. Consistent employment is the best way to demonstrate that.
To qualify for any mortgage, you’ll need proof of sufficient, reliable income. Your mortgage broker will walk you through the income documents your lender will need to verify you’re employed and earning enough income. So, if your employment situation is questionable, you may want to reconsider a home purchase until your employment is more secure.
Should you continue with your home purchase after you’ve lost your job?
What if you’ve already qualified for a mortgage, and your employment circumstances change? Simply put, you must tell your lender. Hiding that information might be considered fraud, and your lender will find out when they verify your information prior to closing.
If you’ve already gone through the approval process, then you know that your lender is looking for steady income and employment.
Here are some possible scenarios where you may be able to continue with your purchase:
- If you secure another job right away and the job is in the same field as your previous employment. You will still have to requalify, and it may end up being for less than the original loan, but you may be able to continue with your home purchase. Be aware, if your new employer has a probationary period (usually three months), you might not be approved. Consult your broker.
- If you have a co-signer on your mortgage, and that person earns enough to qualify on their own, you may be able to move forward. Be sure your co-signer is aware of your employment situation.
- If you have other sources of income that do not come from employment, they may be considered. The key factors are the amount and consistency of the income. Income from retirement plans, rentals, investments, and even spousal or child support payments may be considered under the right circumstances.
Can you use your unemployment income when applying for a mortgage?
Generally, Employment Insurance income can’t be used to qualify for a mortgage. The exceptions for most financial institutions are seasonal workers or people with cyclical employment in industries such as fishing or construction. In this situation, you’ll be asked to show at least a two-year cycle of employment followed by Employment Insurance benefits.
However, it’s not the ideal situation and most lenders won’t be willing to approve your mortgage under those conditions.
What happens if you’re furloughed (temporary leave of absence)?
Not all job losses are permanent. As we’ve seen during the COVID-19 pandemic, many workers were put on temporary leave. If you’ve already been approved for a mortgage and are closing on a house, your lender might take a “wait-and-see” approach and delay the closing if you can demonstrate you’ve only been furloughed. In these cases, you’ll need a letter from your employer that has a return-to-work date on it. Keep in mind, if you don’t return to work before your closing date, your lender will likely cancel the approval and ask for a re-
If you haven’t started the application process, it would be wise to wait until you are back to work for at least three months to demonstrate consistent employment.
Your credit score and debt servicing ratios may change because of lost income, which means you may no longer meet your lender’s qualifications for a mortgage. While it may not be possible, try to avoid accumulating debt or missing any payments while unemployed.
Talk to your mortgage broker.
“You don’t want to get locked into a mortgage you can’t afford.
You also don’t want to lose a deposit on a home because you lost your financing.
When trying to assess if it’s better to move forward or walk away, we should be your first call.”
Mortgage Mark Herman; Calgary Alberta Mortgage Broker
The latest in giant payout penalties, this one was $47,291.
Here is a person – one of my ACTUAL ALMOST-Customers who had to swallow a surprise at TD for $35,000. (We tried 3 times to get him to not take that mortgage.)
To make this even more mind blowing, at a 39% tax rate that is $65,700 the person has to pay … about the same as 1-year of income at a full time job, without tax taken off.
- Would you work for 1 year to give it all to your bank if you had to sell or move or close down the mortgage for any reason?
- Would you sign an agreement like that?
- Have you already signed an agreement like this without knowing you have?
EASY to AVOID …
You don’t need to add in this risk to your home purchase. It is easy to get around by taking a mortgage from a major Broker Bank.
Broker banks calculate the payouts the “old way” which was way more fair to you, the buyer. Click here for the posts about payout penalties.
Broker banks also have better Terms & Conditions than the Big-6.
“Broker Banks have better T&C than all of the Big-6. Call a mortgage broker first.”
Mortgage Mark Herman, Top Rated Calgary Mortgage Broker
TD is/ was the 1st and only bank to charge higher mortgage prime rate for their mortgages.
TD is now the 1st of the big banks to now charge interest on their late-interest-owed:
For the high-end buyers, we find most people have Private Wealth banks that can pretty much do anything … and we don’t win lots of deals for more than $1M+ unless it is a complicated deal.
If it is complicated, you have a private “general banker” trying to either “figure it out for the first time,” or remember how it works. Not the data a high-end buyer wants to rely on when structuring complicated trades in real estate.
SLIDING SCALE DOWN PAYMENT:
The 1 thing that does make a difference for high end buyers is the sliding scale – where their bank does 20% down on the first $750k and then 50% down on the balance. This 50% on the balance is the deal breaker.
We have Broker-lenders (totally secure, including 1st National, Canada’s largest lender with $110 Billion on the books) that will do 20% down on the entire purchase.
That could be a difference of 200k – 400k of down payment in the end. That often means selling more assets, in turn triggering more tax consequences longer term. A high price to pay for a nice home via your “private wealth” bank.
Our big advantages for high-end buyers are:
- the Sliding Scale where the bank’s “Risk Dept” will not bend on the LTV/ down payment %.
- This can save 200k in lower down payment and lower medium-term, tax consequences.
- Payout Penalties are 500% – 800% – yes 5x to 8x higher at the Big-6 banks over Broker lenders who use the “old way” to calculate the payout penalties.
- The very, very detailed math is here: https://markherman.ca/fixed-rate-mortgage-penalties-larger-than-ever/ (you have been warned… this is math city.)
Always call a mortgage broker before buying a home. Especially if you are using a Private Wealth Banker. … Mark Herman, Top Calgary Mortgage Broker near me.
In March the federal government unveiled changes to the budget that included an interesting opportunity for prospective first time home buyers through an enticing program that they called a “shared equity mortgage”. This program could see Canada’s housing agency (CMHC) kicking in up to 10% of the purchase price of a home if certain conditions are met, therefore bringing down the mortgage load and monthly payment for first time home buyers.
In June, the federal government released further details for the new CMHC program. Under the fine print for the First Time Home Buyer Incentive Program, which will officially launch in September, the program is limited to first time buyers who earn under $120,000 annually. The CMHC would kick in up to 10% of the purchase price of the home, as long as the borrower comes up with the minimum down payment for an insured mortgage, which is currently 5%.
An additional stipulation is that the total value of the mortgage, plus the kick in from CMHC don’t exceed $480,000. According to government officials, this means the program will really only aid those shopping for properties worth a maximum of about $565,000, regardless of whether or not they have met the other requirements.
The “loan” from CMHC would be interest free, meaning no compounding costs to pay down, like a mortgage does. In exchange for its stake, the government says CMHC would get to participate “in the upside and downside of the change in the property value” – meaning they would be entitled to any corresponding increase in the value of a home when the buyer sells. On the other hand, CMHC would also be responsible for any share of the loss if the property depreciates.
This means on a home costing $500,000, if the buyer contributes $25,000 (5% down payment) and CMHC kicks in the same amount, CMHC would own 5% of the home. If the home were to appreciate to $600,000 when the home owner wants to sell, they would have to pay 5% of the sale price – in this case, $30,000 – not the original $25,000 CMHC contributed to begin with. Therefore, there will always be a bill to pay down the line. With that said, the kick in from CMHC would reduce the mortgage load and monthly payments, therefore making it easier for first time buyers to save over the life of the loan.
This table from CBC News shows the impact of a borrower of CMHC’s program. On the left is the cost if they went it alone. On the right shows how qualifying for CMHC program makes the same house more affordable:
Savings Over Time
While many are in support of the new program because it will help first time buyers and families across Canada, some financial advisers are not so sure. Rajiv Bissessur says “the program will likely help some people, but ultimately it amounts to just another form of debt for over leveraged borrowers.” It is an interest free loan, but a loan that will need to be paid back nonetheless.
Bissessur also said the cap of $480,000 won’t do much to help people who are shopping in more expensive markets, who are ultimately the people who need it the most.
The program must be paid back within 25 years, or whenever the buyer decides to sell. There is no financial penalty for buying CMHC out of its stake at any time, however homeowners will have to pay CMHC the fair share of the value of the home at the time.
We have yet to see if this program will prove to be “worth it” or if it is election promises.Mark Herman, top Calgary Alberta mortgage broker