Brace for Aggressive Rate Hikes in 2010 Says Laurentian

rising-mortgage-rates That’s according to a research report last week from Laurentian Bank.

In it they state:

  • We think most of the tightening will occur after the jobless rate has peaked (in the first half of 2010) and before total and core inflation get back to the 2% target (in mid-2011).
  • The first hike cannot occur before the third quarter of 2010 in our view.
  • An aggressive tightening – rather than a gradual one – will be necessary because rates are extremely low.
  • A “measured pace” would not be appropriate to “normalize” rates when the starting point is virtually zero.
  • “For argument’s sake, if we assume the Bank hikes by 25 basis points for each of the 12 fixed interest rates decisions in a year and a half starting in July 2010, the overnight rate would be only 3.25% at the end of 2011.”
  • “3.25% could well prove to be too low for an economy that would be running at a decent pace with inflation already at the 2% target. This means we are likely to see a mix of 50, 75 and even 100 basis points hikes…when the time comes!”

Laurentian-BankIn sum, Laurentian Bank suggests rates could jump 3%+ in the next few years, starting in 9-12 months.

Do others agree?  Well, if they do, not many are putting it on the record.

Real estate bear, Garth Turner, is one exception.  He says BoC chief, Mark Carney, “knows he’s playing a high-stakes game of rate roulette, aware ultra-low rates can do as much damage as good.”  Turner believes Carney will be “adamant” about controlling real estate and inflation with higher rates.

If rates do start ramping up next year, it could have two meaningful implications:

  1. Canada’s real estate market would no longer have interest rates as a support mechanism.(This recent Royal LePage survey reinforces how critical low rates have been for sustaining home demand:  Link)
  2. Highly-leveraged homebuyers (with little savings or equity) could be in for some hurt.Let’s consider, for example, a homebuyer taking out a $250,000 mortgage (including default insurance).

    He or she jumps into a 3.35% three-year fixed rate with a 35-year amortization.  All is dandy.

    Then, rates rise 3% in the next 36 months and payments jump 39%…from $1,008 to $1,401.

    If he or she has a high total debt ratio (for example:  42-43%), a $400 payment increase would inflate the borrower’s debt ratios like a balloon. That could:

A)  Strain or break the monthly budget; and/or,

B)  Force him/her to renew with the existing lender at “rack rates” (i.e.,  whatever average-Joe renewal rates the lender is offering at the time.)

The borrower would probably be unable to switch to another lender with a better deal because a 39% higher mortgage payment would push the total debt ratio over the 40-44% limit.  For similar reasons, he/she wouldn’t be able to refinance or move and port their mortgage. This would be the case even if income rose the typical 2.3% a year (the average annual income increase over the last 10 years).

There are naturally exceptions to the above, but you get the idea.

Long story short, rates can and do go up.  Once we start seeing more robust GDP and inflation reports, you’ll see more economists increasing their rate projections.  While some people are advising to buy now because rates are low, not everyone should take that advice.

  1. I sure hope rates don’t spike too much over the next 30 months or so. I’m about half way through a 5 year at 5.09%.
    Looking back I would have been better in a variable, but looking forward maybe not . . . I’m happy with my rate and terms though and in the end i guess that’s what really matters.

  2. Hmmm I’d kick myself hard if I was stuck in a 5.09% 5-year :-|
    I’m not even too pleased being in a 4.3% 4-year from 2006. But a 5.09% 5-year gives me the willies

  3. You need to give your head a shake, Jack, if you can’t handle a 1% variation in rates how will you tolerate it when rates go up 3% or even more in the future.
    When you renew it might be smart for you to consider locking in for a very long time (like 10 years) so that you don’t get burned the next time your mortgage comes up for renewal.
    People should be well aware that the rates right now are about as low as they can go, and any movement in rates is going to be higher. The only question is how much higher and when they will start the steady climb back up.
    I personally think it is going to be another year or so before the US economy will really recover enough for that to happen, but there are signs already that things are starting to change.

  4. @ Donald – You may be reading too much into his comment. He may be saying that with historically low rates at the moment, he’d be kicking himself if he was locked in at a comparably high rate. Everything is relative.
    At least that’s what I’d be doing. Instead of locking in at more than 5% in Jan 2008, I went with the research and decided to go variable. I’d be kicking myself if I was paying 5%+ instead of the 1.30% I am currently enjoying. Hindsight is 20/20, but it’s the biggest financial windfall I’ve ever experienced, by far.
    Al R

  5. My wife and I are shopping for the best rate for a mortgage right now. 2.5 year credit history, but excellent behavior on all fronts. Our bank came in at 4.55, $150,000 on 5 years fixed.
    We went for a second opinion and this time got $220,000 at 3.99 on 4 years.
    Last we asked, they offer 3.95 on 5 years. I was thinking about going for a 10 years. However, some maths make me hesitate:
    – 10 years are around the 5.25% to over 6%;
    – first 5 years, we’d pay more, over the current 5 years at 3.95;
    – the last 5 years, we could still be paying more than current rates at the time, so in the end, as we don’t know what is going to happen, it seems wiser to go for 5 years closed.
    But it’s confusing for me, average Joe, to navigate the waters of this world of finance. I totally agree with the comment about “teasers”. It creates a whole lot of fine prints that test many finance agents’ integrity, as not all know what to tell their potential clients so as not to scare them away, in my opinion.
    And it tests our faith in the loan system of banks and brokers, a faith that has to rely on people and not so much on advertised structures and numbers.

  6. its amazing how many people seem to be mortgage experts these days and they almost all got the lowest rates on record apparantly!
    I’m 2 years into a 5.69% 5 year fixed rate mortgage, and at the time that was a GREAT DEAL. Most mortgages were over 6%. So, please people, those fortunate enough to have been buying property in the last year or so when rates are the LOWEST EVER, please spare a thought for the VAST MAJORITY of people who are paying much higher rates without any option of refinancing (unless they are willing to take the tens of thousands of dollars penalty due to IRD penalties).
    In hindsight, of course variable would have been better back then but 2 years ago the world was different place and there was considerable risk in going variable for most ordinary people.

  7. @ Alan – perhaps you were close to the max gross debt threshold and it would have been risky for you, but the available evidence does not support the view the 2 years ago there was considerable risk for “most ordinary people”.
    Feel free to correct me if I’m wrong, but it seems as though there is more risk in going with a variable today, with discounts off prime unavailable and prime having nowhere to go but up.
    It was an easy call to go variable for me 2 years ago. Why does anyone need to spare a thought for the “VAST MAJORITY” of people who locked in to fixed rate mortgages? They’re paying exactly what they expected to, and locked themselves out of benefitting from lower rates. That’s the tradeoff.
    Al R

  8. I get a little concerned, when I read that interest rate will go quite a bit up, is not that what caused crash in US, first couple years people paid really low interest rates, when the rates were going up the affordibility on 400000 mortgage was gone, is not it exactly what is happening right now, because of low interest rate people are taking big mortgages and little bit increase in interest at the time of renewal will make is difficult for them, unemployment adds to it, unless we all get double digit(%) increase in our salaries.

  9. well, the bottom line is there is no bottom line…but like everyone says, rates have nowhere to go but up, the question of course is when for the variable honks, and for the fixed fans, there is nothing to worry about. You are locked in, the end.
    Mark Carney hasnt backed down from what he has reiterated all year long, barring major changes the rates will stay low…for now.

  10. Fixed rate guys also will have renewal coming in max 5 years, what will they do then, if rate is 6% then compared to 3.85 now?

  11. “……what will they do then, if rate is 6% then compared to 3.85 now?….”
    If locked in at 3.85% for the next 5 yrs…Dump as much extra money on your mortgage as possible in the next 5 yrs.
    Problem solved.

  12. …and that’s why, when going on variable, one has to arrange payments as if they were 4% more than they are in reality.
    When rates go up, they’ll have to go substancially high to change anything on my payments and, in the meantime, I see the capital going down way faster.

  13. The simple answer is DON’T buy the MAXIMUM amount of home that you can afford. I have bought 3 homes and each time we made sure that we always bought WELL within our means. Our last home we bought and are living in — we qualified ONLY on my wife’s income (I make more money too). If you do this and interest rates go up then you have no problem. If you cannot afford a 3% increase in rates then DON’T buy the home. It’s very simple.

  14. Renu,
    The crash in the States was not because of higher mortgage rates. Rates have gone up and down throughout history. The crash was caused because people who should NEVER have been given a mortgage had TWO or THREE mortgages. These sub prime people didn’t qualify for mortgages like people always had to — they had low income levels and no down payments often. This debt was then repackaged and sold to regular citizens via mutual funds etc. The writing was on the wall from the beginning it was just a matter of time. The fraud that took place with mortgage lenders and brokers turning a blind eye to facts and then straight out lieing contributed to the magnitude of crash.

  15. The times of “prime rate – x” are gone now. Anybody thinking of a new variable rate mortgage will get “prime + x”, which makes is very risky now. So to me, fixed is a king for new mortgages.

  16. Variable is still fine, if you have the option to lock in at anytime.
    I was one of the fortunate ones to buy my house when the rates were dropping. Started at 3% variable, and now at 2.25% variable. I believe most banks/CU’s give the option to change from a variable to fixed rate at any time (make sure you find out the rules on your mortgage, CU’s usually better). I will most probably lock in a 5 year at 3.8% in Feb/Mar, and take advantage of the lowest rate while the mortgage is at its highest.
    Just keep an eye on the BoC rate announcements, and make sure you lock in before they start pushing up the rates in 3rd quarter 2010.
    Good luck with the $$ savings!
    DS.

  17. DS. I may be reading between the lines on your post but I think you are misunderstanding what it means to lock in. You state that you will lock in a 5 year at 3.8% in Feb/Mar.
    You also state, “Just keep an eye on the BoC rate announcements, and make sure you lock in before they start pushing up the rates in 3rd quarter 2010.”
    It seems to me that you believe you can lock in your variable at the “days” variable rate. This is not the case. You will be able to lock into a fixed rate, but the fixed rate will be at that days fixed rate. Further to this, the BOC announcements do not influence the fixed rate that you will be locking into. Fixed rates tend to loosly follow government bonds. If fixed rates start to go up you will be able to enjoy your variable where it is until at least June 2010, however where the rate is that you will lock into will be is anyones guess.

  18. any one know why in canada we no longer get offered a 25-yr fixed mortgage rate? (as compared to the US) as most amortizations are for 25yr (or 35-yr), it would really help buyers to have a fixed payment for that duration.

  19. Re: “This means we are likely to see a mix of 50, 75 and even 100 basis points hikes…when the time comes!”
    Was that the bank’s exclamation mark or yours?

  20. Hi Sage: It costs lenders more to secure capital for 25-year mortgages. In turn, they have to charge higher rates than most people want to pay in order to make a profit.
    By contrast, 5-year mortgages for example, can be easily securitized (resold) so there is a relatively endless source of funds for them. That means lower costs for the lender and more popular (i.e. lower) rates for borrowers.
    Cliff: It’s Laurentian’s exclamation point. Not ours…
    Cheers,
    Rob

  21. Really interesting thread.I know its difficult to predict the future of rates ,even for BOC head. If i hv to choose betwwen 2.05 varibale closed with an option to move to fixed any time and fixed at 3.75, 2.05 is the one i will chose if prime does not change much till 2011 end.even prime at 4 in 2 years is also not bad. but anything beyond 4 will defintely going to hurt.
    In next 5 years how far prime can go provided the economy rebounds to its original as it was 2 years back ?
    JS

  22. @JS
    Prime dropped 4% since 2007. It can quickly go up half that much or more. I don’t know why anyone would take chances with a variable mortgage. Go fixed and sleep easy.
    D

  23. with the current expectation of rising mortgage rates in early to mid 2010, can someone kindly advise, based on past experiences, what generally tends to happen in such instances to house prices? do they move upwards due to increase costs or lower based on less affordability from potential buyers due to higher borrowing costs. thank you.

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