Interest Rate Update

Interest-Rates Inflation will accelerate to 3% in the next few months according to Laurentian Bank’s Carlos Leitao.  That’s well above the Bank of Canada’s 2% target.  If Leitao is right, mortgage rates could very well continue their ascent.

CIBC, for example, predicts “100 basis points of hikes coming in 2009 as Canada’s inflation problem heats up.”

On the other hand, Bloomberg’s economist survey suggests rates will remain the same until at least December…for what that’s worth (their last survey wasn’t too accurate).

Talk of rate hikes has many Canadians shying away from variable-rate mortgages lately.  Invis’s Mark Olkowski, however, isn’t convinced fixed rates are now the way to go.  Olkowski says, “Right now, if it was me that had the variable, I’d be sticking with it because I’d look and say that even with that increase that’s expected to happen, (you’d save) money over that net period of time.”

Of course, there’s a multitude of factors to consider so talk to a mortgage planner for specific advice.  Ask them to show you the worst case scenario of a variable-rate mortgage.  If you can handle the worst case then a variable is worth a look.

Sources:  CMT, Bloomberg, Canadian Press

  1. One thing to really worry about is if the Liberals get in to power and introduce the carbon tax grab. This will cause inflation to spike FAR worse than predicted here, and those with Variable mortgages will be hit really hard. That’s one thing they don’t mention on their green shaft website.
    The worst case scenario for Variables is that we end up seeing 12-15% rates for a while. That makes a 1618.98 payment on a 25 year 300K 4.25% mortgage get as high as $3738.44. I’m not sure I know too many families that can take a hit like that.
    Granted, that scenario isn’t very likely, but rates getting to 8% for variables isn’t even out of the ordinary, which would make the payment 2289.64. Add ot this that if inflation is causing problems that means all of the stuff they need to buy to live will be more expensive too. It seems to me that 2009 is going to be a pretty tough year for Canada.

  2. Traciatim,
    If you are going to post “scare statistics”, please cite either your sources or your data. The majority of economists (including conservatives) support a Carbon Tax. Dion’s proposal is essentially stolen from a Conservative Think Tank policy from Calgary.
    I’m inclined to think that a fixed-payment variable is the way to go. That way, you are already insulated by a rise of around 1.5%, and if it remains lower, the extra goes directly to principle. Since you need to qualify at the higher payment, it also indirectly forces new buyers to purchase homes within their price range.

  3. I’m no Liberal and I’m no fan of Stéphane Dion, but blaming the carbon-tax problem for the inflation threat is ridiculous and shows how low political discourse has sunk in our country. If governments — Liberal and Conservative, Republican and Democrat — weren’t so slavish towards big oil and big money over the past 20 years, we wouldn’t be going through such economic uncertainty right now. And we wouldn’t be choking on so much pollution either…

  4. Hi,
    I currently have fixed-payment variable (with prime – 0.5). Should I be looking into the RateCapper product? The going rate seems to be prime to 7.5% right now. I can survive with 7.5%, but man… 8 – 12% or may be 15%?? I don’t think anybody in variable today planned for that jump. Although, I am sure I can survive that higher rate after making adjustment to my life style… who wants to pay the bank 12%?

  5. No credible analyst is predicting anything close to 8-12%. There’s probably a better chance of Tanzania winning gold at the next World Junior Hockey Championship than those rates coming to pass in the near future.
    Anything is possible, but if you’re inclined to believe that interest rates are going to triple in the next few years, you’re among the most paranoid people around. These sorts of predictions are the reason a strong majority of people have fixed rate mortgages even though it’s very likely to cost them thousands upon thousands of dollars in extra interest.
    It sells books for people like Garth Turner, but it destroys a lot of household wealth for people that listen to their ‘sky is falling’ hysteria. Good if you own financial shares, I guess.
    Al

  6. Hi Al R,
    I think it’s worth pointing out that there aren’t many credible analysts anymore. The majority of them looked to the south and said that subprime was contained. Most predicted no recession on either side of the border. The credit crunch caught all the credible analysts by surprise. And of course very few saw Canadian housing prices even leveling off, let alone falling in many markets.
    I see taking a fixed rate mortgage as the same as having house insurance. You probably won’t need it, but you’ll be glad if you do.

  7. Hi Al,
    Great name by the way. ;)
    Although I do believe it is sensible in some cases to go fixed (especially if you can’t carry a higher payment), I don’t think the comparison to home insurance works.
    Insurance is to protect against catastrophic loss, and in normal circumstances the difference between going fixed and going variable is going to be a few to several thousand dollars, ultimately depending on how big your mortgage is. For most people, that doesn’t qualify as catastrophic.
    My broader point is that there is a lot of alarmism around with people predicting massive interest rate hikes. Based on what – one month’s spike in CPI and a suddenly hawkish Bank of Canada? Read the latest statement – risks have tilted *slightly* towards inflation. If/when rates do rise, it will probably be mid-late 2009, and unless things change radically, the change will most likely be modest and incremental.
    Is there a very slim possibility that interest rates will go absolutely crazy? I suppose, but what is the balance of probability? What does the research say? No analyst is going to be correct 100% or even 75% of the time, but it seems like it would be smarter to base decisions on reasonable assumptions rather than whatever Garth Turner happens to be peddling at the moment.
    Al R

  8. Yah, gotta love the name Al. Doesn’t get much shorter or simpler than that.
    The reason I compare insurance to fixed mortgages is the possibility of major rate hikes. We’ve seen interest rates at > 10% in the not so distant past. I think for many this would be catastrophic.
    For instance, someone with a 20 year amortization on 200K at 4% would be paying 1200/month. Raise it to 12% and you’d be paying close to 2200/month. If the increased payment leads to foreclosure, then it’s almost as bad as your house burning down without insurance. Rates going to 12% may not be that likely, but neither is your house burning down. I do agree that people who can afford the upside risk of a spike in interest rates should consider the variable rate.
    Have you ever considered why the lenders have lower rates on variable? I believe that the foregone interest is, for them, a premium paid to insure against holding low yield mortgages in a high interest environment. The question is who pays the premium and who takes the risk?
    By the way, Garth Turner is calling for lower rates. I don’t think I’ve seen his logic behind that call.

  9. Hi Al – I didn’t mean to imply that Turner said interest rates are going up (although I see that I did), only that he is a good example of a modern day (real estate) doomsday prophet. I suppose there are two types: (1) the ‘real estate has nowhere to go but down’ crowd, and; (2) the ‘interest rates are headed into the stratosphere’ crowd.
    To address the latter: since the Bank of Canada explicitly adopted an inflation target in 1991, interest rates have been historically low. This is not an accident or a random period of good fortune.
    In the past 15 years, prime has been no higher than 9.75%. Over the last 10 years, prime has ranged from 3.75% to a whopping 7.50%, with an average of 5.49%. (http://www.bankofcanada.ca/en/rates/interest-look.html). The most interest rates ever rose within this period is 2.50%. Can you call anything beyond 15 years the “not so distant past”? The biggest hit single of 1993 was Meatloaf’s “I will do anything for love”, incidentally.
    I can do the math as well as anyone – if rates go up to 12%, people (including myself) will indeed be screwed. But it just ain’t going to happen within 5 years, especially with the persistent signs of economic weakness that we’ve seen lately.
    cheers,
    Al R

  10. Hi again Al R, I have to say I’m enjoying this discussion.
    I’ve noted that the central banks have been keeping interest rates low for many years now, and I believe they intend to do so for now.
    What’s caught my attention is the banks’ response to the low rates in a high risk environment. For one, they’ve increased their risk premium a bit, but not too much to draw attention to it. Secondly, they’ve reduced the amount of loans they’re providing. It appears to be a simple case of reduced supply when prices are kept artificially low.
    The really big news is the financing from the hedge funds and sovereign wealth funds. They’re charging rates that are much higher than a bank would. I see the HF and SWF setting an actual market rate for lending, which is much higher than the artificially low rates set by central banks. If there is in fact a higher market rate being established by non-traditional lenders, how long will it be until central banks must follow suit?
    BTW, check out the mortgage rates in the 80s and early 90s. Alot of double digits in there. The business cycle will take us back to high rates, but the real question is when.
    http://www.bankofcanada.ca/pdf/annual_page52_page53.pdf
    One final thought, if the average rate over the last 10 years was 5.49% and you could lock in an equivalent rate, why not do so?

  11. Hi Al – I am enjoying this as well.
    I don’t have much knowledge on HFs or SWFs, but my understanding is that central banks can keep it up indefinitely, as long as the commerical banks follow their lead.
    Absolutely agree that there were some scary rates in the 80s and (very) early 90s, but given an explicit inflation target and actions to match, it’s very very very improbable that those will pop up again.
    To answer your final thought, with a decent credit history, you’ll get a discount off of prime. So your average effective variable rate over the past 10 years would be well under 5.0%.
    Would also point out that the spread between prime and fixed (currently 1.35 percentage points at ING) is something a variable borrower realizes immediately. For someone starting off their mortgage, this is a big advantage, because the interest generated from that extra 1.35 compounds over as much as 40 years.
    What this essentially means is that prime has to rise by much more than the spread for a variable borrower to come out behind, and that increase would have to happen quickly, and early in the term.
    I’m trying to find a scenario in the last 10 years where someone would come out significantly behind on a variable, and I can’t find any. Not too hard to find the opposite, though. I could stand to be corrected though – I’ll try to run a couple scenarios during some downtime tomorrow.
    cheers,
    Al R

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