mortgage news, homebuyers

3 Reasons Canadian Mortgage Rates Will Never Hit 5%

High borrowing rates are a relic.

Canadian regulators may soon force borrowers to qualify at interest rates two percentage points above the contract rate.

With many posted mortgage rates now approaching and even surpassing 3.00% (depending on the term), this means borrowers will soon need to show they can afford payments based on rates of 5.00%+.

The justification is that regulators want Canadians to be prepared when interest rates rise, but that’s a hollow excuse. It’s a punitive macroprudential rule that is disconnected from reality.

Interest rates can only rise if inflation accelerates, but every force in the world is pushing in the other direction. We’re in an age of no inflation and it will completely change borrowing, lending and how the mortgage market works.

Here are three reasons you will never have to pay 5.00% on a typical 5-year fixed mortgage, but why you could be paying more in other ways:

1) There Is No Inflation

There is only one kind of inflation that matters to the Bank of Canada: wage inflation. Prices might rise on everything for a year or two, but if wages don’t go higher with them, the cycle hits a wall because people won’t have the money to pay those higher prices. Demand falters and prices flatten.

The classic wage-price spiral of the ‘70s and ‘80s will never return and here’s why:

The simple Economics 101 model is supply and demand. As the economy grows and companies expand, the supply of idle workers eventually runs out. That means more bargaining power for workers and wages rise. It’s something the Bank of Canada calls the “output gap” or “slack”.

This paradigm is now forever broken. The first reason why is that globalization means the supply of workers is no longer limited to where you are. Factories and many service industries can move to where workers are cheapest, and until there are jobs for the billions of workers on the planet there will always be slack.

Even if all those workers could find jobs it still wouldn’t matter because automation is a far bigger driver of disinflation. Workers everywhere are being replaced by technology. It’s not just robots, but also computers, algorithms and improved processes adopted from abroad. We are still in the very early stages of this change and it’s accelerating daily.

Add in de-unionization, Amazon-style competition, precarious labour, other technology and the lingering collective psychological shock of the financial crisis and it’s a Quantitative Easing-miracle that prices haven’t fallen already.

This isn’t just a Canadian phenomenon. It’s not even a developed market phenomenon; inflation is low virtually everywhere. Even emerging markets that are growing far faster than Canada’s economy aren’t generating runaway inflation.

China’s economy continues to grow at a nearly 7% annually, but inflation is just 1.8% and has been below 3% for four years. Average mortgage rates for homebuyers there remain under 5.00%, and until rules were tightened this year, borrowers were typically paying less than 4.00%.

2) The Pain Would be Catastrophic

The second reason that rates will never rise to beyond 5.00% in Canada is that there are now far too many people who wouldn’t be able to make their payments. The government’s last round of new mortgage rules was a noble effort to reign in the housing market, but the horse has already left the million-dollar barn. Many borrowers would be forced to sell their homes, and those who could afford to stay would have their spending power cut dramatically.

A two-percentage-point rate increase on a $500,000-mortgage boosts the payment by at least $500 per month. A 5.00% rate on a million-dollar mortgage means $50,000 spent per year in interest alone. That’s a devastating bite out of a household’s disposable income, which is crucial for sustaining the economy.

Canada is often described as a resource economy, but it’s far more dependent on the health of the consumer than the price of oil. If consumers begin to suffer, it will quickly show up in the economic data and the Bank of Canada would be forced to do a quick U-turn on rates.

Even if Canadians could afford those higher rates, it would be a disaster politically for any governing party. Making people feel poorer is a sure-fire way to find yourself voted out of Parliament.

3) Rules Are the New Rates

While there is no inflation in the classic sense, prices are rising. You don’t need to look any further than soaring real estate or sizzling global stock markets.

The crux is that there are two types of inflation. There’s the classic consumer inflation, which is tied to industrial, commercial and labour prices that are doomed to stay low forever.

Then there is asset-price inflation. Low rates have changed the economics of borrowing and investing. If you can borrow at 3.00%, virtually anything that returns more than that is a viable investment. So asset prices rise until even meagre returns are no longer economical. Add in scarcity, tighter land-use rules, foreign capital and the growing desire to live in urban centres and it’s a perfect storm for housing.

Ultimately, this is a big political problem. People want to live in cities and it’s unpopular for voters to be spending all their money on mortgage payments. It’s also bad for business to have workers commuting unreasonable distances.

There are two real solutions and two that governments will try first.

The ultimate solution to high house prices is to make it easier and cheaper to build more housing. That’s politically unpopular now but could change someday. For now, governments continue to make it tougher to build the homes people want at prices they can afford.

The other way to cool house prices is to raise interest rates, however that’s far too blunt of a tool. Forcing businesses or rural homeowners to borrow at higher rates would be an unnecessary blow. The Bank of Canada has already gone too far.

The two solutions governments are trying first are the two things they always do in a market crisis: blame foreigners and blame the speculators.

So far the execution has been sloppy, but politicians have sent a powerful signal that they are now part of the equation. So don’t worry about interest rates, worry about what’s coming from regulators.


Adam Button is Chief Currency Analyst and Managing Editor of ForexLive.com, one of the most-visited sites for foreign exchange news and analysis.

mortgage news, homebuyers
    1. I agree. It won’t take much.

      At the same time, house prices could fall just on the psychology of the market changing. If people stop believing house prices will rise, then there is no way a one-bedroom Etobicoke condo should be selling for $500K.

  1. Interesting perspective! One key assumption underlying your argument is that central banks have limitless power to control rates; that as long as they do not have a rational to raise rates, rates will stay low. I can see two ways in which rates could raise, despite your reasons. First, the central banks might have to raise rates if the cost of keeping them low outweighs the cost of raising them. You identified several reasons why higher rates would cause problems, but can you think of systemic problems caused by persistently low rates? One area to look at is asset inflation, which you touched on: low interest rates make assets more expensive. The second possibility is a liquidity crunch despite the central banks actions. The central bank wields awesome financial power, but currency is not infinitely malleable, and short of Quantitative easing x to the power of n, I don’t think you can eliminate the possibility of liquidity crunches, which would cause higher rates.

  2. Politicians don’t set Bank of Canada interest rates, In terms of rates never hitting 5%, “Never say never”.

    This article is a useful contrarIan indicator that higher mortgage rates are probable, to potentially 5% and above.

  3. I agree,it is my opinion that raising the rates does more damage than good. Just that fact alone wont stop them ,inflation does exist look at the prices of housing materials, food literally everthing is insanely over priced. These prices do not reflect the actual current rate of inflation…they reflect the Canadian priced version. Every product that comes here from the US is subject to “canadian price” , this is charged to the businesses even with the same name.This amount of increase set to all products except for lumber and a few other products. If we pretend that we are actually getting no.1 grade for the same price which isn’t the case. The government has capitalized on the average person and are being tag teamed by large corporations.

    This state of Canadian price guidelines or normalcy is causing companies to charge more for products to the point where you would have to become a supplier of a product to even make it financially worth buying in the first place.

    This sort of abnormal inflation in canada does exist. Even the trade minister has said that this is a huge problem that has not been addressed, there is no guidelines or rules protecting our market when it comes to price.

    Your are correct that the rates will rise too high then drop down at some point. I wish the same could be said about products them selves apples to apples.

    If your unsure look at the price of asprin or other smaller over the counter medical products that you wouldn’t normally shop for abroad.

    We are treated similar to that of Ireland when it comes to price gouging.

    I realize that the Canadian dollar is lower but 120 to 200% mark up retail to retail apples to apples is ridiculous.

    Just with non prescription drugs and medical supplies alone a monster list of examples can be made with in hours. And its the entire market not just a product here and there.

    This may seem like it has nothing to do with the subject but in fact it has all the ingredients.

    Or perhaps you should tell all the canadians ordering items to the border and driving to pick up one or two products that over inflation doesnt exist?

    There is no need for accelerated inflation if it’s already over inflated.

    Houses are made of products and even the items stored within it or outside in the yard.

    I am not challenging your technical data or expertise in any way..just wanted to say inflation is over and above the natural level when it comes to products. With out products nothing would exist in the first place.

  4. Historically rates have AVERAGED 5~6%. It’s the current ridiculously low rate that has created this mess to begin with. The shortage of housing was largely caused by investors leaving homes empty and flipping instead of renting. Whoever says rates will never reach the pain point doesn’t remember the early 1980s. (15% !!) Speculators were able to do this through artificially low interest rates. The Canadian gov’t was partly responsible because the lowered the rate considerably to get Canada through the oil price crash a few years ago.
    Rates must go up to wean Canadians off of cheap money. They’ve used the system to create a huge debt burden while using their homes as leverage through HELOCs.
    A mortgage rate of 5% or more is not only likely….. it’s normal. In fact with OSFI’s mortgage stress test, they will effectively be 5% for many people anyway. Bring it on. Yes, many people will not be able to afford a home. Then housing prices will have to come down. That is the way to make housing more affordable.

  5. The most expensive commodity everyone buys is housing (renting or buying), doesnt 30-40% jump in housing costs qualify as inflation?

    1. By central bank definitions, it really doesn’t. The BOC only really cares about wage inflation. The thinking is that if wages don’t rise, the price of everything else can only rise so far.

  6. If rates continue to stay low you’ll see pensions and mutual funds implode 8-10yrs down the road. Also, why own debt if equities keep out preforming? What interest rates then.

  7. As much as this theory is great for a long term expectation of low mtg rates for a mortgage broker like myself (and many of us reading this article) and ultimately our clients, saying “There is no Inflation” is naive. Low rates means low bond/fixed income returns and likely a long term low Canadian dollar, for starters. The invisible hand still has some effect in a modern market economy . Keynesian economics isn’t infallible.

  8. Lets be clear. No way are these asset prices sustainable. We are just entering yet another asset bubble.

    How do governments fund themselves? What tools are available to them? Will those tools be available to infinity with debt being piled on? What interest rate would the market demand when it looks like govt’s ability to repay looks suspect?

    Never say never. SP 500 Shiller PE ratio is higher than 1929 and the third highest in history. Housing prices are not sustainable in Canada…unless of course it continues to be attractive for foreign buyers with the cash to come in a prop it up. But none of this is sustainable and words like “never” in the markets are used by the ignorant of history.

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