Mortgages holders have been having a blast with the lowest interest rates they will likely see in their lifetimes. However, it now looks as though the economy has been doing so well in rehab that the low interest diet is changing to something with a little more protein.
Although Mark Carney and the Bank of Canada elected to keep the benchmark rate at .25%, they expect the economy to rebound by the second quarter of next year. Analysts now expect higher rates by June 1st.
“I think the government is making it quite clear to Canadians that the direction of interest rates is upward,” says Jim Smith, vice-president of Scotia Mortgage Authority.
The federal government recently told banks that they use the 5 year fixed rate as the benchmark to qualify people for mortgages.
“Instead of using the rate that is about 2% above the existing variable rate as the benchmark, we now use 3% above the variable rate to act as a buffer,” says Smith. “I think that probably sends a signal about what the finance department thinks the future holds for us.”
Sensing a change, the bond market pushed its lending rates higher and triggered a serious uptick in mortgage rates at Canadian banks at the end of March. Homeowners got a hint of what’s to come when rates jumped by 6/10 of a percentage point at most banks.
Because market shifts always tend to over do it, rates could slide slightly in the next few weeks.
“The trend line is clear. The only way is up,” says Peter Kinch, one of Canada’s best-known mortgage industry professionals and author of ‘97 Tips for Real Estate Investors’.
Although everyone is hanging onto Carney’s every word, Kinch says it’s the bond market that needs watching. The Bank of Canada’s overnight lending rate is linked to variable mortgage rates, but it is the bond traders who dictate the fixed rates.
“Only about 30% of Canadians have variable rate mortgages,” says Kinch. “The rest are fixed and those are in the hands of the bond traders.”
“Look at what Mark Carney is saying. The Bank of Canada is comfortable with the dollar going up to $1.10,” continues Kinch. The tolerance for a high dollar, as Kinch reads it, means the bank has the stomach to raise rates higher and faster if it thinks inflation will bust through its target 2% band.
A recent report by the Royal Bank of Canada states 66% percent of Canadians are concerned about mortgage rates creeping higher and 49% say their mortgages are higher than they thought they would be at this stage of their life.
From here on in, suiting up with the right mortgage strategy is going to be critical for homeowners. “No matter who I am talking to,” says Kinch, “I ask them to conceive that we are going to see a 3% increase in mortgage rates over the next three years.”
When talking to clients you need to “find out what they are capable of and what are they comfortable with,” Jim Smith from Scotia Mortgage Authority advises. Locking into to a five-year fixed “is the kind of advice I would give to someone who is fairly well mortgaged up with a debt service rate of 40%.”
Peter Kinch puts it another way. “If the time stamp on the email I get from them is 3 a.m., I know it is keeping them awake”. In that case says Kinch, he tells them to lock-in at the five-year-rate.
However, if the homeowner has a small mortgage or a lower debt load there are other plays available. Scotia offers a “Step Mortgage” with multiple terms and types of mortgages within it. “You could put half in a fixed rate, half in a variable rate or you could ladder it – or even put part of on a line of credit,” says Smith. “It is really the industry’s leading product.”
If clients understand the difference between the Bank of Canada’s role and the bond market’s thinking and their circumstances are right, Kinch offers a different strategy. “Keep the variable rate but keep making payments as if they (the client) were paying a fixed rate,” he says. “When they renew at the higher rate, they’ll renew at a lower principle. You will have saved a chunk of money and you will have adjusted to payment shock.”