30 Oct What Determines The Mortgage Rates We Pay?
Canada’s economic engine ultimately determines the mortgage rates we pay. And these days, that engine is running at a lower RPM than in the past.
“Canada’s economy is in a new age,” says Desjardins Economics. In a report released last week it states that economic growth potential “will remain between 1.5% and 2.0% from now until 2030.”
If this call is even remotely true (remote being the most we can expect from an economic forecast), then we’ll have gone from a 3.3% real average growth rate since the 1960s to as low as 1.5% for the next 15+ years. A healthy growth rate is closer to 2.5%.
Is it any wonder then that Desjardins concludes: “…interest rate equilibrium levels will be lower than in the past?” At these stunted growth levels, even risk-haters may start considering variable mortgage rates.
Economic growth is the main lever that elevates and lowers inflation, which in turn increases and decreases mortgage rates. It’s highly unlikely that an economy progressing at just 1.5% long-term — or even 2% — can generate sustained inflation above 3.0%. (3.0% inflation is the Bank of Canada’s maximum tolerance, above which it tends to hike interest rates.) Against that backdrop, 2.25% variable rates start looking far more appetizing.
As more reports like Desjardins’ surface — and others have — people will increasingly consider variable or short-term mortgages, especially if/when interest rates finally jump 75 to 125+ basis points. Such rate increases would put us much closer to long-run equilibrium rates (the rates that neither fuel nor suppress inflation) and significantly improve the risk/reward profile of variable mortgages.
Any suggestion to go variable has caveats, however. For one thing, floating rates are inappropriate for folks who cannot comfortably handle spikes in interest cost.
Variables are also less certain given that 5-year fixed rates are just ½-point more expensive. Historically, that’s a petite premium to pay for rate certainty. That premium seems even more reasonable given the chance of government bond yields “new-normalizing” (i.e., rising to a level that maintains 2% inflation in a slower economy).
So despite the long-term attractiveness of variables in a low-growth world, the math today still puts fixed and variable terms in a horserace. A modest 75-basis-point rate hike, starting one year from now, would actually make a fixed rate less expensive based on 5-year interest cost alone. (There are exceptions, of course. One example: If you terminate your mortgage early, fixed penalties will make you curse your lender’s name.)
At this very moment picking between fixed and variable still isn’t clearcut. But once the Bank of Canada takes rates back up, the lower long-term growth potential of a mature economy could create one of history’s most opportune times to go variable. At that time, variable rates should once again become the best bet for most qualified borrowers.
In the meantime, slower long-run growth doesn’t negate the possibility of medium-term rate hikes, and the value of today’s fixed rates.