Falling interest rates have cut the cost of financing the purchase of a home, buying a car, renovating your kitchen and more. Unfortunately.
Lowering rates looks irresponsible if you care about the personal finances of the nation. Savers are penalized, and borrowers get encouragement they just don’t need. The fact that the Bank of Canada went ahead anyway with a cut of half a percentage point in its trendsetting overnight rate tells you how concerned it is that the coronavirus will push the economy into recession.
The drop in the overnight rate will be reflected in borrowing costs for variable-rate mortgages, lines of credit and floating rate loans. Rates on fixed-rate mortgages are falling as well, but this is connected to plunging interest rates in the bond market. The housing market does not need help from lower rates – it was already surging in several cities.
Meanwhile, Canadians are so overburdened with non-mortgage borrowing that this category of debt is hardly growing these days. A decade of low rates has left many households tapped out and stressed about it.
The reason why the Bank of Canada went ahead with a rate cut highlights a point we may have forgotten in this era of low rates. When a central bank cuts borrowing costs, it’s a negative event. This is particularly so when the cut is half a percentage point, rather than the typical change of a quarter point.
Coronavirus has caused a sharp decline in global stock markets and oil prices, shut or slowed down factories in some countries and hurt the all-important tourism industry. Canada has been less affected by the virus than many other countries, yet our economy is still vulnerable.
It’s now the worst time to borrow money since the global financial crisis. Yes, the virus might fade out in a month or two, allowing lost economic growth to be recaptured later in the year. But if not, it’s conceivable that the economy could lapse into a recession that affects the security of your job and your income.
Wages have actually been rising at a brisk rate. Average hourly wages in January were up 4.2 per cent over the same period last year, which is roughly double the recent inflation-rate trend. Our economy wasn’t exactly strong precoronavirus, but it did have enough momentum to keep the unemployment rate low and wages rising.
The temptation to exploit lower rates will be felt most among home buyers desperate to get into a real estate market that in several cities is already hot. In Toronto, for example, sales in February jumped 45.6 per cent over the low level of a year ago, and average prices jumped 16.7 per cent to $910,290.
Lower mortgage rates will help with affordability. If variable-rate mortgages fall by half a percentage point from discounted levels at the start of March, monthly payments on a home bought at the average national resale price of just more than $500,000 would fall by close to $120 a month. Of course, lower rates will also juice demand for homes and push prices higher.
Fear of indefinitely-rising house prices is what’s driving many first-time buyers to get into the market despite a borderline ability to afford life as a homeowner (not just the mortgage and property taxes, but maintenance, car loans and daycare for children). Can anything stop prices from soaring in cities with strong real estate markets? Might coronavirus do the deed?
It’s way too soon to say, but the fact that the Bank of Canada and also the U.S. Federal Reserve have slashed their benchmark rates suggests a high level of worry about the virus. Only if your job is secure and your finances secure should you consider these rate cuts as encouragement to borrow.
The biggest victims of the Bank of Canada’s rate cut are savers. Expect to see rates on high-interest savings accounts fall, followed later by guaranteed investment certificates. GICs take their cue from what’s happening in the bond market, where rates have also declined.
There is one group the Bank of Canada has helped in a significant way: People who already have variable rate mortgages and/or lines of credit and floating rate loans. Their interest costs will fall as banks adjust their rates to reflect the lower overnight rate. Enjoy the relief, borrowers. Don’t blow it by borrowing more.
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