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The long-awaited interest rate U-turn is finally at hand.

Rates began rising from pandemic lows in March, 2022, and have been flat since last summer. We are still far from unwinding those recent rate hikes, and it’s unlikely that we get back to the old lows. But the trend is clear: slowly and haltingly, borrowers will pay less and savers will make less. Here’s a summary of what you need to know following the 0.25-of-a-percentage-point drop in the Bank of Canada’s overnight rate on Wednesday:

Savings rates

Banks and credit union savings account rates reflect a variety of factors such as the overnight rate, what’s happening in financial markets and comparisons to competitors. But a drop in the overnight rate sends a clear message to savers – prepare to see declines in rates that are now as high as 4 per cent or so.

Mortgage rates – and lines of credit

Rates for mortgages are mainly influenced by what’s happening in the bond market, where expectations of a rate cut by the Bank of Canada have already provided some downward pressure on bond yields. Fixed mortgage rates could follow.

TD Bank economist Rishi Sondhi recently said he expects the interest rate on the five-year bonds issued by the federal government to fall by about 0.4 of a percentage point in the second half of the year, which suggests potential for a similar decline for fixed-rate mortgages. Many homeowners are renewing mortgages later this year and next. They’ll pay a higher rate than they did last time, but potentially not as high as we’re seeing right now.

Borrowing costs for variable-rate mortgage holders increased each time the central bank increased its overnight rate. Now comes the unwinding. People with variable-rate mortgages, which adjust automatically to changes in rates, will see a drop corresponding to the change in the overnight rate. Other variable-rate mortgages left payments static while rates rose, which meant less money going toward principal and thus a longer amortization period. Lower rates will start the process of reducing those lengthened amortization periods.

People who owe money on lines of credit will get some relief as well – exactly a quarter percentage point’s worth if banks reflect the full cut in the overnight rate in their own prime lending rates. Borrowing costs for lines of credit are based on the prime rate plus a markup of varying amounts.

The housing market

It’s expected that lower mortgage rates will entice buyers sitting on the housing market sidelines, but Mr. Sondhi said a big upturn for home price seems unlikely. “The affordability backdrop is still likely to remain pretty stretched,” he said. “Our forecast doesn’t anticipate Canadian home sales returning to their pre-pandemic level on a quarterly basis until next year.”

There’s been talk in the real estate world that buyers are on the sidelines now waiting for lower rates to improve affordability. A rush of buying would end up making houses less affordable.

“If prices go up very quickly, that will completely annihilate the relief you would get from a slightly lower mortgage,” said Dominique Lapointe, director of macro strategy for Manulife Investment Management.

GICs

GIC rates follow the same market trends as mortgages, so get ready for returns to start drifting lower. Yields on one- and two-year GICs have held up well lately, with 5-per-cent returns still widely available on Wednesday from alternative players. Competition between GIC issuers to attract money may help keep rates in this zone for a while, but the general trend is lower. Procrastinating in buying GICs means foregoing yield.

High interest savings ETFs

These exchange-traded funds hold their assets in big bank savings accounts paying much better rates than retail clients can get – about 4.8 per cent as of earlier this week. HISA ETFs tracked each increase in the overnight rate – expect the opposite now that rates are falling. “If the Bank of Canada cuts by 25 basis points, you would expect to see the rate of those ETFs go down by the same amount,” said Naseem Husain, senior vice-president and ETF strategist at Global X Canada. Expect a rate adjustment within 24 hours of the Bank of Canada’s rate change.

Similar rate cuts are likely for investment savings accounts, an alternative to HISA ETFs. Investment savings accounts are packaged like mutual funds and typically can be traded at no cost, compared to commissions of up to $10 for buying and selling HISA ETFs.

T-bill and money market ETFs

ETFs and mutual funds holding treasury bills and short-term corporate borrowings will react to the lower overnight rate, but not as directly as with HISA ETFs. Mr. Husain said the T-bill fund at Global X, formerly Horizons ETFs, holds bills maturing in up to three months. As they mature and new securities are added, the yield will fall.


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