Dave Larock in Interest Rate Update, Mortgages and Finances
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When the spread between five-year fixed and variable mortgage rates is narrow, as it has been for the past two years, most borrowers have opted for the stability of the fixed rate.
That makes sense because on the one hand, they aren’t getting paid much of a discount to take on variable-rate risk, while on the other hand, the premium they have to pay for the stability of a fixed interest rate is minimal. In fact, at some points in our recent past the best five-year fixed rates were equal to or even better than their variable-rate equivalents.
This is no longer the case. The gap between our fixed and variable rates has widened of late, and my read of the tea leaves says that it will continue to do so in the near future. Today’s post explains why.
Let’s start with variable rates, which can be expected to increase when the Bank of Canada (BoC) raises its overnight rate (assuming that you don’t have a variable-rate mortgage with TD, which recently increased its variable rates on its own).
Last week the BoC left its overnight rate unchanged, as was universally expected. In its brief accompanying statement, the BoC noted the following:
Against this backdrop, I think it’s a pretty safe bet that the BoC isn’t going to raise its policy rate for some time yet, and that means that prime rates, which our variable mortgage rates are priced on, aren’t likely to move higher for the foreseeable future. Instead, the Bank will continue to use dovish policy language to jawbone the Loonie down while hoping that the U.S. Federal Reserve follows through on its plans to raise its policy rate in the near future. Speaking of which …
Canadian fixed mortgage rates are priced off of Government of Canada (GoC) bond yields which have moved in virtual lock step with their U.S. equivalents since the start of the Great Recession. As such, when the U.S. Fed starts talking about raising its policy rate and U.S. bond yields rise in response, our fixed mortgage rates get taken along for the ride (a ride that can be likened to holding onto the tail of a rather large tiger).
To be clear, I am not convinced that the U.S. economy can withstand higher rates on a sustained basis because I believe slower-than-expected growth and aging demographics will continue to assert downward pressure on U.S. economic momentum. But our fixed mortgage rates are still likely headed higher in the near future, and perhaps throughout 2017, because the Fed sounds determined to tighten its monetary policy over the short term.
Five-year GoC bond yields rose eight basis points last week, closing at 1.17% on Friday. Five-year fixed-rate mortgages are available at rates as low as 2.44% for high-ratio buyers, and at rates as low as 2.49% for low-ratio buyers. If you are looking to refinance, you should be able to find five-year fixed rates in the 2.69% to 2.84% range, depending on the terms and conditions that are important to you.
Five-year variable-rate mortgages are available at rates as low as prime minus 0.80% (1.90% today) for high-ratio buyers, and at rates as low as prime minus 0.60% (2.10% today) for low-ratio buyers. If you are looking to refinance, you should be able to find five-year variable rates in the prime minus 0.45% range (2.25% today), depending on the terms and conditions that are important to you.
The Bottom Line: Our variable mortgage rates are priced on the BoC’s overnight rate, and it doesn’t look as though the Bank will be raising this rate over the foreseeable future. Meanwhile, our fixed mortgage rates are priced on GoC bond yields, which generally move in lock step with their U.S. equivalents. Since the Fed is expected to tighten its monetary policy in the near future, we should expect our fixed-mortgage rates to be pulled higher when U.S. bond yields rise in response. As this happens, expect the spread between our five-year variable and fixed mortgage rates to increase, and the appeal of variable-rate mortgage options right along with it.
David Larock is an independent mortgage planner and industry insider specializing in helping clients purchase, refinance or renew their mortgages. David's posts appear weekly on this blog, Move Smartly, and on his own blog: integratedmortgageplanners.com/blog Email Dave