The new normal is rising interest rates.
The first step up for rates from the emergency low of the pandemic has been taken by the Bank of Canada and more increases are ahead. Here’s a realist’s take on who’s better and worse off as we adjust to the move away from what could be the lowest borrowing costs we’ll see in our lives.
Better: Home buyers and owners
You thought anything house-related would be listed on the worse side, right? Won’t rising rates hurt affordability in a market that is already too expensive by virtually all rational measures? The answer is yes, let’s hope so.
Price growth in the housing market needs to cool down and higher rates can help accomplish this without overtly damaging the market. Housing is important to the economy and a crash in the sector would undermine growth at this key moment of transitioning away from pandemic restrictions.
Slower growth in house prices, or even zero growth for a while, is a win because it will help first-time buyers get into the market, even as they face higher borrowing costs. Saving a down payment is demoralizing when prices keep rising by double-digit amounts over year-ago levels. A quieter housing market is good for long-time owners as well because it reduces the risk that prices will rise to unsustainable levels and then fall hard.
Worse: Households struggling to cope with inflation
Stubbornly high inflation is a big reason why rates are rising right now – higher rates are supposed to cool demand for buying goods and services. This cooling process takes a while, though. In the meantime, we will have higher costs for food, gas and other staples, plus higher borrowing costs.
We are entering a tough period for households with big grocery bills, two vehicles to fuel up and debts like a line of credit where the rate is directly influenced by the Bank of Canada’s overnight rate. There will likely be further rate hikes in April and beyond, and inflation could be headed higher if the Russian invasion of Ukraine keeps pushing up the price of energy, grains and other staple commodities.
Better: People who recently took out variable rate mortgages
Wait, doesn’t the interest rate on variable rate mortgages rise along with the Bank of Canada’s overnight rate, which was increased by 0.25 of a point on Wednesday? Correct, but take a look at how much lower variable-rate mortgage costs have been lately in comparison with fixed-rate loans.
Some of the big mortgage brokerages had five-year variable rate mortgages as low as 1.1 per cent this week, with five-year fixed rate mortgages at 2.79 per cent to 2.99 per cent. There is room for the Bank of Canada to increase the overnight rate by at least 1.5 percentage points in total without pushing the cost of a variable rate mortgage above the current fixed rate.
Worse: People who chose fixed rate mortgages and have to renew this year or next
Discounted five-year fixed rate mortgages went for about 2.35 per cent in early March, 2017, according to the Ratehub.ca historical mortgage rate database. As noted above, discounted five-year fixed rates today are close to half a percentage point higher than that right now.
Rates on five-year fixed mortgages are influenced by five-year bonds issued by the federal government. Rates on these bonds have backed off lately because of Russia’s invasion of Ukraine. Money flows into bonds in uncertain times, which has the effect of pushing interest rates lower.
But rates on bonds were on the rise before the invasion and can be expected to start rising again at some point. Higher costs for fixed rate mortgages are likely in the months again.
Better, but not really: Everyone who has money in savings accounts
The rising rate trend should result in better rates in savings accounts, but the improvement will be negligible. Prior to this week’s move by the Bank of Canada, 1.25 per cent was a big win for people with high-rate savings accounts. With inflation running at 5.1 per cent, savers will be getting a negative real rate of return for quite some time to come. Rates will have to rise a lot, and the inflation rate will have to drop sharply.
Savings accounts are still the place to keep money you want to keep safe, mind you. Do not trust the stock or bond market right now with money you can’t afford to lose.
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