Why no rate hike means variable mortgages are safe again

A signal from the Bank of Canada that it is not raising its key lending rate any time soon, coupled with the likelihood of falling mortgage rates, could be enough to keep the latest housing rally going.

There’s been a sea change at the Bank of Canada. For the first time in more than a year, policymakers have dropped any reference to rates eventually rising.

There have been signs the housing market is in recovery mode with year-over-year sales rising in many markets, albeit generally below 10-year averages. Analysts have called it a short-term blip caused by consumers rushing to buy to take advantage of pre-approved mortgages signed 120 days ago when long-term rates were lower.

But with the Bank of Canada signaling Wednesday it won’t be raising rates — its neutral stance could even mean lower rates — consumers can safely slide back into variable mortgages tied to prime which tracks the central bank rate.

The short-term rate option and the possibility long-term rates will follow has people worried the market may be recovering too fast for the taste of Ottawa, leaving Finance Minister Jim Flaherty with no choice but to tighten lending rules again.

“It’s possible interest rates will go down,” said CIBC deputy chief economist Benjamin Tal, adding there’s a huge amount of mortgage debt already in the pipeline that was created when people took advantage of rates they were pre-approved for in the summer. “I’ve seen what is in the pipeline in mortgage activity and you won’t believe the numbers when it is official.”

With no panic to buy, the question is whether people will be encouraged to continue to take on more debt or slow down their spending if the economy slows?

“If we don’t get the softness we are expecting [in housing], quite frankly I think they are already talking about more restrictions,” said Mr. Tal, adding that would be the only option to slow the housing market if Ottawa is reluctant to raise rates.

Kelvin Mangaroo, president of RateSupermarket.ca, says long-term mortgage rates have so far not followed recent reductions in bonds yields, making the variable rate look all the more attractive.

He says the lowest variable rate mortgages on a five-year term is now 2.4% which compares with 3.34% for a five-year fixed closed mortgage. The major banks are still offering 3.89% for a five-year fixed rate closed mortgage.

“The rule of thumb is people start looking at variable when there is a one percentage point spread between five-year variable and five-year fixed,” said Mr. Mangaroo. “We might have more people looking variable with the latest Bank of Canada news.”

Most of the banks and Ottawa have taken great pains to get people to lock in the mortgage rate so they won’t be vulnerable to a spike in interest rates. Changes to mortgage rules even allow you to borrow more, as long as you lock in for five years or longer.

York University Prof. Moshe Milevsky said historically there is usually a much larger gap between long-tern rates and short-term rates which were almost the same earlier this year. He’s not sure people will flock to variable immediately.

“It’s not as much demand side with the consumer deciding. The banks can push aggressively on variable. Sometimes it’s about how the mortgage broker is compensated. There are two sides to the transaction. The consumer is educated when they make the decision,” he says.

While Mr. Milevsky is hesitant to make any prediction on the housing market because so many people have been so wrong for so long, he does have a suggestion for anybody worried about what type of mortgage to take out today.

“I continue to marvel at why people go all fixed or all variable,” says the professor, adding while banks don’t promote the option, you can  ask that half your mortgage be long-term and half be short-term. “If I was consulting the banks, and I’m not, their advertisement campaign should be “hedge your mortgage debt, do both’.”

Phil Soper, chief executive of Royal LePage Real Estate Services, thinks it’s reasonable to believe people will move back to variable but probably not enough to cause concern about the housing market.

“Look across the country and many regions are not Toronto,” said Mr. Soper, who cautions government policy should not be based solely on the hot real estate market in Canada’s largest city.