If you’re getting a five-year fixed mortgage today, rates will likely be more than one percentage point higher by the time you renew. That’s what Canada’s bond market is now pricing in.
What’s more, Canada’s five-year swap rate, a benchmark that lenders refer to when pricing five-year fixed mortgages, is the highest it’s been since last April.
When swap rates surge, it means lenders are making significantly less on fixed mortgages – unless they raise their rates.
This should be an eye-opener for anyone getting a mortgage in the next 120 days.
(For the record, the five-year swap rate closed at 1.0511 per cent on Tuesday; it was 1.0855 per cent in April, according to Bloomberg.)
Lenders under the gun
The gap between the lowest nationally advertised five-year fixed rates and the five-year swap rate – think of this as lender’s gross profit margin – is now the smallest it’s been in three years.
In fact, it’s less than 10 measly basis points from the smallest gap we’ve ever seen. (There are 100 basis points in a percentage point.)
If this upswing in lender funding costs continues, you’d better believe that lenders won’t eat it. They’ll start lifting rates.
Meanwhile, five- and 10-year fixed mortgage rates are still at their all-time bottom – as low as 1.23 per cent to 1.64 per cent for five-year money and 1.98 per cent to 2.14 per cent for 10-year money. Those are tasty rates under any circumstances, let alone with the market pricing in meaningful rate increases.
For the reasons above, it’s not hyperbole to say that if you need to lock in a long-term mortgage rate, there has literally never – ever – been a better time to do it than right now.
How high could rates go?
A guess would be total folly, given all the unknowns about vaccine progress, new viral variants, government stimulus spending, government bond issuance, oil prices, supply constraints that fuel inflation and so on.
For all anyone knows, another mega-COVID-19 wave could shut down the economy all over again, forcing rates to new lows.
But in the mortgage game, you play the odds. And the odds suggest this recovery is slow and bumpy but real. The government is throwing all it’s got at the crisis to get people spending money again and the unemployed working. That will boost inflation back above the Bank of Canada’s 2-per-cent target, and by the time it does, fixed rates will have climbed – as they always do at the start of an economic cycle.
Canada’s recovery will be different from the past, however. Central banks usually hike rates before an economic resurgence gets too hot. This time, the Bank of Canada pledges to let the recovery run hotter for longer.
That, coupled with unparalleled stimulus and central bank bond-buying, will ultimately reignite inflation. Albeit, variable-rate mortgagors may still enjoy another year or two of prime rate at 2.45 per cent.
Looking ahead past 2021, mortgage shoppers must ponder two realities:
For one, we’re now past the low of this economic cycle, if you believe the market and economists – meaning there’s greater risk of higher inflation (and higher rates) ahead than of lower inflation (and lower rates).
And second, mortgage selection is about risk control. Locking into a record-low five-year fixed rate – from a flexible lender that does not have punitive mortgage-prepayment penalties – is an effective way to manage interest rate exposure.
Consider that for every quarter percentage point that rates run up from here, borrowers will pay more than $3,300 more interest over five years, on a typical mortgage balance with a 25-year amortization.
This is why, prepayment penalties aside, most people who need new financing for the next five years should ask one fundamental question: Why wouldn’t I lock in until 2026?