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Robert McLister: Optimistic borrowers could face difficult decisions in 2025 as a different reality hits them
Published on December 13, 2024 • Last updated 16 hours ago • 4 minutes reading time
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Homes and Townhomes in Langley, BC Photo by Darryl Dyck/The Canadian Press files
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The variable rate fever is slowly spreading as more mortgage buyers float their rates thanks to the Bank of Canada's 175 basis point rate cut.
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But like someone betting their retirement on a stock tip from their barber, these optimistic borrowers could potentially face tough decisions in 2025 as a different reality comes their way.
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Here's what I mean.
There are many risks
Let me start by saying that if you paid me in gold bullion, I wouldn't be able to predict tomorrow's weather, let alone one year's interest rates. Nonetheless, here's what keeps some business psychologists awake at night:
- Inflation has continued to rise, partly due to a statistical quirk called base effects and partly due to persistent underlying price pressures.
- Donald Trump's cocktail of deregulation, tax cuts, immigration policy and tariffs is widely viewed as inflationary.
- Aside from the unemployment rate, employment and income in North America continue to rise – supporting spending – despite interest rates that our central banks consider “restrictive.”
- If bond yields rise above the 2024 highs, this could mean significantly higher interest rates.
- Short-sighted government spending on both sides of the border could push interest rates higher.
All of this flies in the face of why hopeful variable rate fans choose to fluctuate their rates. Variable rate borrowers expect Canada's key interest rate to continue to fall. That's a correct assumption only if most economists and the bond market outlook are correct, but it says nothing about how long interest rates will stay low.
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As of this writing, traders are expecting two to three more interest rate cuts from the Bank of Canada next year. But here's a quick tip about future implicit interest rate paths: They change. In fact, they could well change next week as we get forecasts for the future from the all-important Federal Reserve meeting as well as critical inflation data on both sides of the border.
As for the tough decisions I mentioned, they come into play when core inflation rises back to three percent or more. This is particularly true for America's key inflation measure, personal consumption expenditures (PCE), which Federal Reserve Chairman Powell tracks like a forensic accountant.
For interest rate floaters, a return to core inflation above 3 percent would feel like watching a horror movie in slow motion. It would shake the confidence of Treasury bondholders and US yields would skyrocket. With a correlation between U.S. and Canadian five-year yields well above 0.90, Canada's federal funds rate and mortgage rates would likely follow a rise in U.S. rates.
The degree of risk
With Canada's economy showing more slack than a discount store suit and Trump tariffs potentially hurting our growth, not many experts are worried about higher borrowing costs by the end of next year. But any homeowner who gets a variable should understand that it is a possibility.
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If central bankers suddenly moved toward tightening, bond yields would rise, driving up fixed interest rates. Many variable rate borrowers who believe they can lock in their loans if necessary would try this. But at that point, bond investors would have expected higher interest rates – and fixed rates would have missed out on mortgage lenders – perhaps by 50 to 75 basis points or more.
Not to mention the fact that most lenders have poor conversion rates to begin with when converting from variable to fixed loans. Gone are the days when banks like HSBC routinely offered transparent, deeply discounted fixed interest rates that variable borrowers could lock into.
Of course, failing to protect yourself from an inflation cycle could be even more costly than getting a lousy interest rate.
As a tip: If your planned way out is fixed, this is a crucial question for your lender: Ask what interest rate you'll get if you convert your variable rate to a fixed rate. Then ask for real-world examples of today's pricing with that lender. Mortgage rates can change, but this will at least give you an idea of how competitive the lender currently is.
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The problem with rate locks is that timing the rate cycle bottoms is like predicting where a penguin will waddle next. And your banker or mortgage broker probably won't be of much help here, because their crystal balls are no better than economists'.
That means banking on interest rates continuing to fall is like betting your savings on a rainless summer in Vancouver. It could happen, but your budget better be prepared for the storm when those clouds roll in.
As a parting tip: If you want to play the variable rate game before next year's uncertainty and don't want to have as much payment risk, consider lenders with fixed payment variable rates. The best are banks like Bank of Montreal and Canadian Imperial Bank of Commerce, which keep payments under control despite rising interest rates. This results in higher interest rates for the borrower and carries the risk of higher payments upon renewal, but at least protects his monthly budget in the meantime. Additionally, history shows that interest rates typically return to normal after a few years.
Robert McLister is a mortgage strategist, interest rate analyst and editor of MortgageLogic.news. You can follow him on X at @RobMcLister.
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