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opinion

If you think about today’s near-record consumer leverage and near-record pace of rate hikes, one thing is clear. Borrowers are trapped in one of the most gruelling rate increase cycles in Canadian history.

Yet, based on their term selection, mortgage shoppers increasingly think runaway rate hikes will reverse within 12 to 24 months.

Data from Statistics Canada show that the percentage of borrowers choosing one-year and two-year fixed rates has more than doubled this year.

At last count in August, almost one in five borrowers (19 per cent) chose a one-year or two-year fixed. That’s up from just 8 per cent a year ago.

Clearly, fewer and fewer people want to commit long-term to unappetizing rates like 5.25 per cent, which is 200 basis points above the 15-year average of five-year fixed and variable rates. (There are 100 basis points, or bps, in a percentage point.)

More and more, people want to play the “go-short-and-refinance” game. In other words, commit to a short-term rate so they can reset lower in 2023 or 2024.

Assuming recession in 2023 mops up excess economic demand and we get no more inflation shocks, that strategy should work out (note the word “should”).

The reward

Your average Federal Reserve rate hike cycle has lasted 21 months since the Fed started targeting the Fed funds rate in 1982, according to Chatham Financial.

The most the Fed hiked in any one cycle during that time was 425 bps. This time around, it’ll likely raise far more – 500 to 525 bps, according to ever-changing futures market expectations.

A federal funds rate somewhere in the 5-per-cent range should be enough to get inflation trending down toward the 2 per cent target.

Why go short?

One-year and two-year fixed rates let a borrower avoid all rate increase risk during those periods. That’s opposed to variable rates, which are almost certain to rise another 50 basis points or more.

Now fast forward 12 to 24 months. If bond yields then drop materially – which they typically do as they start to price in central bank rate cuts – people taking short-term fixed rates today will be able to roll into meaningfully cheaper rates.

The risk

This all sounds good on paper, and it is exactly how yours truly would play it – assuming I were getting a mortgage today.

But I’m not you. Everyone’s circumstances and comfort level differ.

The important point to remember is that risk management is always Job No. 1. The best laid plans oft go astray, and as we heard from Fed chairman Jerome Powell on Wednesday, central banks are more prone to overtighten than under tighten.

On top of that, any number of unknowns could result in inflation remaining stickier for longer.

Consider this. If you took a one-year fixed at today’s lowest nationally available uninsured rate (5.65 per cent), and rates are 200 bps higher in 12 months when you renew, you’d be looking at a $472 payment increase on a 25-year amortized $400,000 mortgage – or $118 a month more payment pain, per $100,000 borrowed.

And I’d be remiss by not mentioning the granddaddy of all surprise rate hike cycles: 1978 to 1981. At the time in 1978, markets thought they had inflation in check. Rates then proceeded to double in 26 months and almost triple in 42 months. That’s clearly an exceptional case historically, but a painful one.

Safety first

Given the risks above, gambling on a one-year fixed isn’t suitable to most – especially for those without significant financial safety nets. Well-qualified borrowers who want to be more certain of getting through this storm should instead opt for at least a two-year fixed.

If inflation overstays, and the Fed and Bank of Canada have to take rates higher, that two-year term provides an extra year of rate shelter.

Also, pick a lender with fair prepayment penalties, if possible. That way, if rates plunge by the end of next year (not a prediction) you’ll be able to break the mortgage to refinance early, hopefully with just a three-month interest penalty.

Can mortgage shoppers expect an easier stress test rate?

Whatever happens, remember that no one can consistently time mortgage rates with precision. Relying on market expectations and history for your rate strategy is fraught with hazards. But at least we know one thing: Canadians cannot tolerate mortgage rates ranging between 6 and 7 per cent for long. That means there’s a rate limit, and we’re not that far from it. So this rate hike cycle will end – very likely in a matter of months or quarters, not years.

Longer-term fixed rates start to edge lower

Five-year mortgage funding costs – those tied to the bond market – have dove in the past nine trading days by more than 40 bps.

As a result, smaller lenders have begun cutting five-year fixed rates by anywhere from 10 to 20 bps. So far, no major banks have moved. And based on this past summer – when five-year yields plunged 100 bps without any meaningful bank rate drops – I wouldn’t expect any serious fixed-rate reductions by the big banks in the near term.

Lowest nationally available mortgage rates

TERMUNINSUREDPROVIDERINSUREDPROVIDER
1-year fixed5.65%Alterna Bank5.14%Quest Mortgage
2-year fixed5.47%Simplii5.14%Quest Mortgage
3-year fixed5.49%Simplii4.99%Quest Mortgage
4-year fixed5.49%Simplii4.99%Quest Mortgage
5-year fixed5.29%Alterna Bank4.94%CanWise Financial
10-year fixed5.94%HSBC5.94%HSBC
Variable5.45%Marathon Mortgage4.75%Nesto
5-year hybrid5.50%HSBC5.56%Scotia eHOME
HELOC5.85%TangerineN/AN/A

As of Nov. 2.

Rates in the accompanying table are as of Wednesday from providers that advertise rates online and lend in at least nine provinces. Insured rates apply to those buying with less than a 20 per cent down payment, or those switching a pre-existing insured mortgage to a new lender. Uninsured rates apply to refinances and purchases over $1-million and may include applicable lender rate premiums. For providers whose rates vary by province, their highest rate is shown.


Robert McLister is an interest rate analyst, mortgage strategist and editor of MortgageLogic.news. You can follow him on Twitter at @RobMcLister.