Central bankers have a simple message for you mortgage shoppers: Interest rates will “remain low for a long time.”
Quotes like this one from the Bank of Canada are motivating some to take more risk, such as selecting a short-term fixed or variable rate to try and time the market, versus locking in to a longer-term fixed.
And for all we know, those risks may end up saving people money.
But there’s one important question such borrowers should be asking: What could go wrong with the low-for-long rate thesis?
The answer: a lot.
Are we misjudging inflation?
The North American inflation outlook is the primary driver of mortgage rates, something those who take a floating or short-term rate should remember. Inflation may be no threat today, but the outlook could change completely by 2024.
Already, 62 per cent of financially secure working Canadians are now “deeply troubled by the prospect of inflation,” says a Canadian Payroll Association survey released on Monday. That compares with just 47 per cent last year.
When a lot of people get increasingly worried about inflation, history has shown it can be a self-fulfilling prophecy.
Counterbalancing that reality are two harsher realities: Unemployment will stay meaningfully above pre-pandemic levels and economic growth “post rebound” will stay meaningfully below pre-pandemic levels for more than just a year or so, if economists are right.
In spite of this, the experts still don’t know how much money Ottawa will keep shelling out to boost consumer spending and employment.
What we do know is that the bond market guides fixed mortgage rates. And bonds haven’t been the trusty indicator of inflation expectations they once were. The reason: They’ve been skewed by our central bank’s bond-buying spree. As of Sept. 8, the Bank of Canada has snapped up more than 30 per cent of Canada’s $1.04-trillion of government bonds and treasury bills.
What all that bond buying has done is artificially drive five-year mortgage rates to record lows. Default-insured five-year fixed rates are now as low as 1.52 per cent while uninsured rates are just 1.84 per cent or less.
It’s hard to say how high rates would be without the purchases by the Bank of Canada. Probably not a lot higher, but certainly some. More relevant, however, is what happens when the central bank stops buying.
The bank is keeping a lid on rates but eventually the economy will recover. It’ll then have to move out of the way, assuming it doesn’t want to own the majority of our government’s debt. When that lid comes off and our jobs come back, bond yields could potentially take flight.
If and when that happens, yields and fixed mortgage rates will move fast. Most variable-rate borrowers hoping to lock in “at the right time” will be late to act.
So many question marks
If we were facing inflation uncertainty in the 1970s, a time when mortgage rates were much higher, we’d have a problem. But today, mortgage shoppers are blessed with record-low rates.
The lowest five-year fixed rates are now just one-sixteenth of a percentage point above the lowest variable rates. That gap is about 10 times smaller than usual. This tight spread is the market telling us that rates could remain low for years.
But what the market can’t tell us is what the market doesn’t know. It can only see a year or two out. And no investors know what happens after politicians spend a colossal $370-billion-plus over 12 months, money they don’t have, to prop up the economy – because it’s never happened.
That worries a lot of smart people. Many still believe that inflation is linked to money creation, and fear the inflationary repercussions of governments piling up debt (creating new money) by the trillions.
It’s partly why investors like Warren Buffett are buying inflation hedges – in his case, gold companies. That’s a 180-degree turn for Mr. Buffett, a man who once said gold “has no utility.” Risk-averse mortgage borrowers should consider his motives.
The cost of being wrong
Inflation doesn’t need to hit double digits like it did in the 1980s. Expectations of even 2.75-per-cent core inflation could be enough to rocket mortgage rates above 4 per cent again.
That should be top of mind for less financially secure borrowers, given: a) fixed mortgage rates are already so close to their eventual bottom, and b) there’s so little upfront gain by floating your mortgage rate.
It would take just a single increase in prime rate, four years from now, to make today’s best variable rates more expensive than a five-year fixed, assuming you didn’t break the mortgage beforehand. And if you choose a lender with a reasonable pre-payment penalty, breaking early is almost a non-factor.
Variable rates have had an amazing run. But we’re now in the trough of an economic cycle with unprecedented government spending, there’s almost no difference between fixed and variable rates and potential inflation risk lies ahead.
In that sort of world, variables are for risk-takers, including hopeful rate timers. And if you’re among the tiny minority who can actually do that successfully, and you have a lender that doesn’t fleece you when you try to lock into a fixed rate, all power to you. Perhaps you’ll lock in closer to when rates lift off and have a lower average borrowing cost, versus going fixed today. But the odds are against you.
Quick tip: Another alternative is choosing a lender with transparent low rates, one that lets you renew your fixed mortgage early with just a three-month interest charge. A rare few, like Tangerine, let you “blend and extend” into a new five-year term any time with zero penalty.
Countless Canadians think rock-bottom rates are here to stay for five years or more. And again, they may be right. But for most, the cost of being wrong about that is a lot greater than the benefit of being right.
Robert McLister is a founder of RateSpy.com and intelliMortgage, and mortgage editor at rates.ca. You can follow him on Twitter at @RateSpy.
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Robert McLister