Welcome to the 6th edition of our Mortgage Newsletter for 2024!
At 9:45 am this morning, Bank of Canada (BoC) announced the latest rate cut decision, decreasing its Policy Rate by 0.25% (from 4.50% to 4.25%). This is the third consecutive rate drop in three meetings, bringing the Prime Rate to 6.45%.
For those with variable rate mortgages or loans, this means another round of reduction in monthly interest costs. Since June 2024, your interest costs have dropped by about $62.50 cumulatively for every $100,000 of debt.
Below are the recent economic updates that likely aided this move:
In Canada: The Consumer Price Index (CPI) has been gradually declining, with July's year-over-year rate down to 2.5% from 2.9% in May. GDP growth remains weak, with no growth reported in June and a preliminary estimate of zero growth in July. Employment growth is also slowing, with job losses recorded in June and July, leading to an unemployment rate that has risen to 6.4% and a decrease in the employment rate to 60.9%.
In the US: Unemployment is on the rise, increasing from 3.9% in April to 4.3% in July. The CPI continues to decline, dropping to 2.9% in July. GDP growth is oscillating, with Q1 growth at 1.4% and a preliminary Q2 estimate of 3.0%.
Given the general softening of economic activity, moderation in inflation and increase in un-employment, a cumulative reduction of another 0.50% in the Prime Rate before the end of 2024 is increasingly likely. I anticipate the Prime rate to moderate to 5.95% by the Dec meeting.
Mortgage Market Insights
Bond Yield and Fixed Rate Spread: The spread between bond yields and fixed rates continues to narrow but remains higher than the long-term average. This spread should decrease as organic demand for mortgages increases.
Fixed vs. Variable Rates: While variable-rate mortgages are still more expensive than fixed-rate options, the difference is shrinking. With today's rate cut, the gap now ranges from 0.85% to 1.10%, suggesting there’s room for further reductions.
Variable Rate Discount: Variable rates are priced at a "discount" to the Prime Rate, but these discounts are currently lower than the long-term average. We can expect these discounts to increase over the next 12 to 18 months as demand for these products rises.
Betting on Prime Rate: Choosing a new variable-rate mortgage or sticking with an existing one means one is banking on a drop in Prime Rate of at least 1.50% within the next 15 months to break even compared to today’s 3-year fixed-rate options.
What Should You Do?
1. Consider a 3-Year Fixed Rate Mortgage: If you’re currently in a variable-rate mortgage and struggling with higher payments, a 3-year fixed rate can offer immediate relief. These rates are competitively priced and provide a compelling option for those seeking stability.
2. Evaluate the 5-Year Variable Rate Mortgage: If you can afford some flexibility in your budget, a variable-rate mortgage could be more cost-effective over the next five years or possibly 3 years. Keep an eye on the spread with 3-year fixed terms, as fixed-rate pricing is falling faster. Consider whether it's worth securing guaranteed lower costs now or holding out for potential savings.
3. Plan for Your Mortgage Renewal: For those renewing their mortgage, a 3-year fixed rate can help avoid the higher payments associated with variable rates. This option also provides the flexibility to renew sooner, potentially at even lower rates.
4. Fixed Rate Mortgage Considerations: If you’re opting for a fixed-rate mortgage, review the terms carefully. A significant drop in interest rates could make it costly to exit your mortgage early due to higher penalties. Make sure you’re comfortable with this commitment.
5. Assess Your Current Fixed Rate Mortgage: If you’re locked into a fixed-rate mortgage with more than 2.5 years left on your term and your rate is above 5%, now is the time to evaluate your switch options. The opportunity to switch may soon become prohibitively expensive, so acting promptly could save you significant costs in the long run.
For detailed insights, keep reading...
Mortgage Interest Rates
Presently, the 5-year bond yield stands at 2.924%, nearly 43 bps lower than 3.368% reported in our last communication on July 24th, 2024. Yields have dropped significantly from the peak of 4.461% (briefly touched on 2nd Oct 2023) and are currently near the lows witnessed in the last 18 months or so.
To offer you a visual insight into evolving trends, we've included charts below. These charts illuminate the trends of various aspects associated with mortgages with a 5-year term, be it Fixed or Variable.
For those unfamiliar with terms like Insured, Insurable, Uninsured, or Rental, a concise explanation is provided in note# 1 below.
Note: The rates indicated below are the most commonly available rates for Prime borrowers. Many Qualified borrowers secure a lower interest rate than depicted below due to superior credentials. Interest rates with B-lenders and Private mortgages are at a premium to these levels.
The charts above show the trend in interest rate (see note#2) for Fixed Rate Mortgage types for the last 35 months or so. The rates have fallen by about 1.30% to 1.40% from their peak in October 2023. For the shorter term (1-3 year) Fixed rate mortgages, the rates continue to be at a premium to corresponding 5-year rates.
Above chart shows the spread between the 5-year Canada Bond yield and 5-year Mortgage (Fixed rate). This spread has been larger than usual for the 24 months or so, but we seem headed back to the average which is around 0.75% to 1.50% depending on the kind of mortgage.
The charts above show the trend in interest rate (see note#2) for Variable Rate mortgage types for the last 35 months or so. Do note the Variable Rate Pricing will adjust later today or tomorrow to reflect the change in Prime Rate. The speed of fall in Variable Rate is much slower than the Fixed Rates given the dependency with Bank of Canada’s decision schedule.
A higher discount on the chart generally signifies a heightened demand for Variable Rate mortgages. It reflects the dynamic interplay between borrower preferences and the response of lenders to this demand. Conversely, a lower discount may indicate a market shift towards Fixed Rate products. We are most likely getting into a phase where more borrowers will opt for a Variable Rate mortgage given potential for reduction in Prime Rate and so the Discount to Prime Rate should be increasing in coming months.
Generally, Fixed rate mortgage rates are higher than their corresponding Variable Rate mortgages at the time of securing one but currently we are in a phase where the relationship is inverse. This typically happens when the interest rate trend is under reversal. There is no guideline as to how long such an inverse relationship can persist but in "normal" times this period is limited to couple of months at best. This inversion has persisted for about 22 months now.
Note: If you need help with your financing options, are interested in working with me or want to learn more about my services, please don't hesitate to get in touch. I'd be happy to chat! Schedule meeting per your convenience here.
1. Explanation of key terms
Insured – These mortgages are backed by a mortgage insurer like CMHC and borrower needs to pay an insurance premium. All properties purchased with less than 20% downpayment fall under this category and come with an amortization of 25 years or lower and purchase price cannot be higher than $1M.
Insurable – These mortgages require the borrower to have a downpayment of 20% or higher, amortization is restricted to 25 years or lower and purchase price cannot be higher than $1M.
Uninsured – These mortgages require the borrower to have a downpayment of 20% of higher but amortization can be 30 year or lower and purchase price can be higher than $1M.
Rental – These mortgages are specifically for Rental or Investment properties and need to have a downpayment of 20% or higher but come with amortization of 30 years (with most lenders) and purchase price can be higher than $1M.
2. Interest Rates depicted are those which are commonly accessible by most well-qualified borrowers with excellent credit and debt service ratios. Some borrowers might be able to secure an interest rate which is lower than these levels on account of superior qualification. Interest rates with B-lenders and Private mortgages are much higher than these levels.
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