Canada’s oil industry is fighting for its life. In 2014, a barrel of crude sold for US$100-plus. This week, supply and demand got so distorted that people literally had to be paid to take a barrel of oil.
Oil’s decline is a mega-trend that will directly or indirectly affect Canadians for decades to come. It will even affect the price we pay for mortgages.
History has shown that variable and short-term mortgages outperform longer fixed terms. The disinflationary effect of oil’s slow demise could weigh on rates and reinforce that trend.
The oil and gas sector accounts for half a million direct and indirect jobs and more than 5 per cent of our economic output. When demand for oil peaks, Canada’s economy will be tested. That could happen as soon as 2025, according to some analysts. Electric-powered transportation, alternative fuels, recycling, alternatives to plastics and environmental pressures are just some of the headwinds.
In the next few years alone, oil industry contraction will “cause a direct hit to [real] GDP of between 0.3 per cent and 1 per cent and the knock-on effects could double the impact,” says Stephen Brown, senior Canada economist at Capital Economics. And that’s on top of COVID-19’s economic blow.
Canada’s growth will average well below its 1.75 per cent annual growth rate as a result, for up to three or more years. History shows that GDP growth under 2 per cent is inconsistent with rising mortgage rates.
A sidelined Bank of Canada
There will be “no increase in [Bank of Canada] policy rates until at least 2023,” Mr. Brown projects. And a similar chorus echos throughout economist-land.
All else being equal, the economic drag from a contracting oil sector could exert downward pressure on rates for more than a decade, past the end of the COVID-19 crisis.
Of course, oil’s economic contribution is one of many factors affecting rates, and it’s impossible to quantity how much its demise will depress Canadian rates over time. But even if rates stay 25 basis points lower than they otherwise would be, every small reduction increases the probability that variable and short-term fixed rates will continue outperforming long-term fixed mortgages. (There are 100 basis points in a percentage point.)
Lower borrowing costs
Calamity in the oil patch and general economic devastation are nothing to celebrate. They’re tragic. But if they’re going to happen, one should at least capitalize on one silver lining: lower borrowing costs.
For those with stable employment, tolerance for rate fluctuations and a financial safety net, the oil outlook and lower growth are just two more reasons to gravitate to variable and short-term fixed rates.
But borrowers need to shift the odds in their favour. And they can do so by finding rates that are at least 35 to 50 basis points below their best five-year fixed rate option. And with average five-year fixed rates near 2.69 per cent, that makes anything near 2.3 per cent or less a bargain. The logic being that you’ll likely be able to renew into a deep discount variable in a few years and keep your average borrowing cost low, despite potential rate hikes.
Now, this might require taking a shorter term than you’re comfortable with, like a one-, two- or three-year fixed. But the interest you’ll save up front compared with a five-year fixed should be worth it.
As for variable rates, they’re currently the only mortgage rates under 2 per cent. If you can snag one sub-2 per cent, it’s a fair bet. You can always pay the three-months’ interest charge, break it early and switch into a deeper discount variable when they become available.
Floating-rate discounts should improve in the next six to 12 months. A year from now, I’d wager you’ll find variables at prime minus 0.75 per cent or better, compared with the average prime minus 0.2 per cent today. (The prime rate in Canada is currently 2.45 per cent.)
For those wondering whether they should lock in an existing variable, don’t even think about it – yet. Rate locks will look a whole lot better if five-year fixed rates go sub-2 per cent, and they could easily reach those depths this year or next.