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Robert McLister: The recent increases may make people nervous, but the real excitement lies in what comes next
Published on Oct 11, 2024 • Last updated 6 hours ago • 5 minutes reading
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Mortgage rates are rising, and that's worrying people hoping for a significant drop in interest rates. Photo by Getty Images/iStockphoto
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Mortgage rates can often be disappointing. Case in point: today. We commentators have been talking about diving rates for months, and yes, they are down. Fixed interest rates have fallen by more than 150 basis points in a year.
But with all the headlines about falling interest rates lately, people are expecting more. And we may not get more for a while.
It's now five months since the Bank of Canada's first rate cut of the cycle, and fixed rates are creeping up like people's blood pressure during tax season.
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Mind you, interest rates are not rising stratospherically, around nine to 25 basis points for some of the lowest advertised fixed rates. Standard insurance rates – used by people with down payments of less than 20 percent – are the most competitive and therefore rise the fastest.
While the recent increases may be unsettling people, the real excitement lies in what comes next.
When central banks start cutting interest rates — especially significant cuts like the Federal Reserve's rate cut last month — it's usually a harbinger of an economic lockdown. And central bankers and economists largely expect such a slowdown to occur – over time.
The question is: What does “timely” mean?
Economies are like slow-moving supertankers. For now, the U.S. economy – which has a strong influence on Canadian mortgage rates – appears to have redirected its course. Markets are starting to predict a stronger expansion than expected.
The Atlanta Fed's real-time GDP indicator, for example, points to a strong growth rate of 3.2 percent. This comes on top of recent American employment numbers that exceeded expectations. And then there's U.S. inflation, which beat forecasts on Thursday despite hitting a 44-month low.
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Canada's interest rate markets are extremely sensitive to any hint of inflation risk, including south of the border. Traders have bet so heavily on interest rate cuts in the next 18 months that they fear they will be wrong and fear they may be underestimating North America's economic resilience. If they're wrong, that means bond yields could trigger a jack-in-the-box effect and skyrocket when we least expect it.
What does this all mean for mortgage buyers?
This is not so much a crystal ball prediction as an attempt to manage borrowers' expectations. While the economy is likely to continue to slow ultimately as interest rates remain well above inflation, we could see a rebound over several months. It's like expecting a hangover to set in, but somehow you're still excited at brunch.
If U.S. employment remains stable and inflation does not continue its downward trend this fall, expect more market anxiety. And the latter is a real possibility, with harsher year-over-year base effects ahead.
Jargon buster: “Base effects” in inflation refer to the impact that the previous year's price level has on the current year-on-year inflation calculations; In particular, if prices were unusually low in a particular month last year, even a small increase in prices this year could result in a higher reported inflation rate.
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There is also the possibility that inflation risk arises for unforeseen reasons, such as an oil shock, continued government overspending, tariffs (looking at you Donald Trump), and onshoring. Fortunately, central bank interest rates that are still elevated, high housing costs, expensive mortgage extensions, high debt loads and artificial intelligence will continue to weigh on interest rates.
The point is that despite an overall downward trend in borrowing costs, interest rates could fluctuate for a while. If you need a fixed-rate mortgage by January or February, you will receive a rate guarantee in case further interest rate increases take longer than expected.
And if you're worried that inflation might make a comeback, consider a hybrid mortgage (part fixed, part adjustable) if you can find one that's close to five percent. That way, you'll be partially protected in the less likely event that inflation gets out of control, but still benefit if interest rates continue to fall, as economists predict.
In other news: the return of 90 percent refinances
Previously, Canadians could refinance their home and take out a mortgage equal to 90 percent of its value. The government put this on hold in 2010 amid fears of rising debt burdens, financial instability and an overheated property market.
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Well, what's old is new. Despite today's almost record-breaking level of debt, political decision-makers again believe that refinancing the loan-to-value ratio of 90 percent makes sense. They return on January 15, 2025. But hold off on your mortgage applications – there's a twist.
To get one, you must purchase default insurance and use the money to build one or more second homes on your property. The maximum allowable property value, including the new suite(s), is $2 million and you can receive depreciation for up to 30 years.
For people who don't have enough money left over to build a mortgage that generates rental income, this could be a viable option. The refinance premium can be high, but the borrower receives a low insured interest rate that is often 30 to 50 basis points cheaper than uninsured refinance rates.
However, some questions still remain unanswered:
- How much are the fees for default insurance?
- Will lenders require borrowers to pay upfront for the construction of the second home or allow withdrawals (partial cash refunds) during construction?
It would be nice if the government disclosed full details of new mortgage programs when making the announcement, but that may be asking too much. Still, this policy isn't too shabby. Rather than stoking demand, it creates much-needed housing, and history shows that insurance losses overall are about as likely as a balanced budget in Ottawa.
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I wonder how many people will accept this program, considering that you can't take on outside debt and borrowers have to cover most of the construction costs. As if we were watching a Netflix cliffhanger, we wait for answers from the Treasury.
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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