Is it too late to lock into a fixed-rate mortgage?

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Borrowers getting a mortgage this month best prepare for more sticker shock. We’re about to see another wave of fixed-rate hikes.

The catalyst: rocketing bond yields, which in turn are being fuelled by soaring oil prices.

Some market pundits are predicting that crude oil breaks its record, which topped US$147 a barrel in 2008. That would be just about the worst outcome for inflation, short of perhaps nuclear war or a giant asteroid colliding with Earth.

And Mr. Bond Market doesn’t like it.

This inflationary threat is, in part, leading investors to sell bonds, thus boosting five-year yields. And yields are a crucial driver of fixed mortgage pricing.

Average uninsured five-year fixed rates are now approaching a 300-basis-point increase over last September. Back then, you could get a five-year fixed for a puny 1.99 per cent. (There are 100 basis points in a percentage point.)

What’s next …

As the price of oil threatens to take yields and fixed rates to another galaxy, we seem to be caught in a “1994 moment.” And there’s no way out near-term.

If you don’t remember five-year fixed rates in ‘94, they shot up 350 bps in five months as central banks urgently hiked their policy rates to ward off inflation.

If we’re lucky, a 1994 replay is all we’ll see. A 1981 replay – a runup of 1,000 bps in 10 months – would be a touch less pleasant. Although in truth, there’s little chance we’ll see even half that.

Stress test Mortgage 101 episode: Everything you need to know about mortgages right now

CIBC economist Benjamin Tal has data going back to 1990 on the interest-rate sensitivity of Canada’s economy. And comparing 1990 with today, “we are 93 per cent more sensitive” to rate hikes, Mr. Tal told me in an e-mail.

In other words, the Bank of Canada doesn’t have to hike as much to slow domestic demand. That’s the biggest reason why total rate hikes in the 300-to-450-bps range are more likely this time around. As we speak, the bond market is pricing in about 350 bps.

One wild card, however, is foreign supply chain disruptions. They’re another major inflation catalyst that’s out of the Bank of Canada’s control, and they could partly offset the rate sensitivity factor.

Too late to lock in?

The question is, what are you going to lock in at? A five-year fixed near 5 per cent?

I don’t think so, not unless you’re a poster child for risk aversion. Five years is a long time to be stuck with a rate that’s 80 per cent above the 10-year average.

With a growth slowdown ahead, the prime rate will revert to its mean. That’s a mathematical certainty. The only key questions are: When, and how much higher, will that mean average go?

The way this is all playing out, the Bank of Canada may have no choice but to break housing’s back by taking its key rate at least 13 times higher than it was on March 1. In other words, to 3.25 per cent or above.

If the bank really wants to head off this inflationary spiral, however, there’s one sure way to do it: shock and awe.

Given how late our central bank is to the fire, and given this year’s massive hit to its credibility, bond traders and consumers must be pounded into believing inflation won’t linger for years.

On June 22, we could see inflation as high as 7.5 per cent. Now that would truly scare people.

Supersized rate hikes of 75 to 100 bps may be the only way that inflation expectations and five-year fixed rates top out this year. But the central bank needs to act fast – before inflation beliefs get even more out of hand.

Real estate sentiment collapse

Canada’s housing market has been geared to 1.99-per-cent rates. Now it’s facing 5-per-cent rates, and stunningly high mortgage qualifying rates. Thanks to the government’s stress test, five-year fixed mortgage applicants will soon have to prove they can afford rates of more than 7 per cent. The last time five-year qualifying rates were that high was in the early 2000s.

People expected rate normalization to pressure home prices, but those expectations were based on rates doubling. If we push deep into 5-per-cent territory on fixed rates, that’ll be a triple. And the implied value of housing – based on debt-to-income ratios (that is, what borrowers can afford) – will slide even further.

Real estate is regional and no mainstream economists predict a panic, given immigration inflows and record-low unemployment. I’m not in the home-price prediction business but perhaps we get a quick V-shaped bottom like the past few housing market sell-offs. But know this. Given record-high leverage – if stress test rates end up in the high 7-per-cent or 8-per-cent range, all bets are off.

Mortgage rates this week …

With yields surging, average five-year fixed rates could be 15 to 25 bps higher within seven to 10 days or so. By this time next week, most banks could be at 4.74 per cent or above on discounted five-year fixed rates.

As always, check regional rates from brokers and credit unions for potentially better deals. In British Columbia, for example, you can still get a killer 3.89-per-cent (uninsured) five-year fixed rate from Community Savings.

Rates are as of Wednesday from providers that advertise rates online and lend in at least nine provinces. Insured rates apply to those buying with less than a 20-per-cent down payment, or those switching a pre-existing insured mortgage to a new lender. Uninsured rates apply to refinances and purchases over $1-million and may include applicable lender rate premiums. For providers whose rates vary by province, their highest rate is shown.

Robert McLister is an interest rate analyst, mortgage strategist and editor of MortgageLogic.news. You can follow him on Twitter at @RobMcLister.