The end of rate increases and why variable rates might be the best solution for many.
During their October meeting, the Bank of Canada (BOC) maintained its policy rate at 5%. This means that the Prime rate (on average 7.20% for most lenders) has remained unchanged, leaving variable rate and HELOC holders with some relief.
The question now for borrowers is if this may be the end of rate increases. Let’s look at the most important sets of data used by the BOC when assessing the direction of future rates:
GDP Growth
This measure gives us a glimpse of the health of the economy. Preliminary data shows that
Canada is in a “technical recession,” which is when there is a drop in GDP over two consecutive quarters. Second quarter we saw GDP drop 0.20%, and 3rd quarter estimates see GDP fall 0.10% annualized. BOC projected 0.80% growth in the 3rd quarter of 2024, so we are way behind target. This trend is clear evidence that higher rates have impacted the Canadian economy, with spending and investments being scaled back.
Unemployment
This measure gives us an idea of the % of unemployed persons in the labour force. When unemployment is too low, it can create inflation, so a rise in unemployment can be a positive
sign in the current environment. Canada’s unemployment rate rose to 5.70% in October (previously 5.50% in September). This is the fourth increase in the last six months and another sign that higher rates are impacting employers' desire to hire.
CPI (Inflation)
One of the most important indicators for the BOC is the average price change for a market
basket of consumer goods. BOC is most interested in ensuring that inflation is under control as this hugely influences their rate decisions, and they target a range of 2-3% as a benchmark for an acceptable level of inflation.
Inflation declined to 3.80% in September down from 4% in August and the trend seems to be downward as core inflation which excludes volatile food and energy costs dropped to 3.20% from 3.60% in August.
Economics Forecasts
Economic forecasts are an excellent tool to understand where rates could end up. These should be reviewed with caution as data changes very quickly, but it is very helpful in attempting to predict what type of mortgage to consider.
On average, most big bank economists predict rates to decrease between 0.50-1.50% from where we are today by the end of 2024. The average forecast is a rate drop of 1.00% by the end of 2024, and some forecasts show rates could decrease by 2.75% by the end of 2025. Currently, the overnight rate is at 5.00%, and Prime is at 7.20% for most banks. A rate decrease would be a huge break for variable-rate mortgage holders.
Why a variable rate solution could be the best option today.
Anyone with a variable rate has seen their mortgage rate increase by almost 5% over the last two years and is likely very shaken by the significant impact on their mortgage payments. The idea of considering a variable rate for most would be counterintuitive to the roller coaster ride we have experienced during the last 24 months and the conventional wisdom to consider a fixed rate.
With rates very likely at their peak and most economists seeing rate decreases in 2024, now may be the BEST time to consider a variable rate again.
With the average conventional 1-2 year fixed rate over 7% and 3-year fixed rates in the mid-6 % range, if you can secure a 5-year variable rate with an attractive discount, this might be the best way to go.
Here's a scenario to consider:
$500,000 mortgage
1-year fixed-rate average 7.44% - monthly payment: $3,437.11
2-year fixed-rate average 6.99% - monthly payment: $3,289.77
3-year fixed-rate average 6.59% - monthly payment: $3,160.77
5-year variable rate 6.40% - monthly payment: $3,100.18
If we expect rates to come down by 1.00% according to forecast reports, a variable rate could be down to 5.40% by the end of 2024 and under 4% by the end of 2025. The fixed rates will remain the same, and more of your principal will continue to go towards interest.
Most lenders also offer variable rates that have the advantage of allowing you to convert to a fixed term anytime, which could make sense once rates have come down and you’d prefer some piece of mind. Variable rates also typically come with only a 3-month interest penalty, so if you need to make changes, consolidate debt, etc., the cost to make these changes is significantly lower than a fixed rate penalty, which could be 3%+ cost on the balance you owe.
How to position yourself today when looking at a new mortgage or upcoming renewal
A 5-year variable/adjustable rate could be the best option for some, but only if the discount is very generous. Most lenders are currently not significantly discounting their variable options, but a handful of lenders are aggressively discounting their variable rate terms.
Assuming, based on the data, that rates will come down in the second half of 2024 for some clients, considering a 1-year fixed rate might be the best option. Current 1-year fixed rates are higher than longer terms but allow the opportunity to renegotiate when rates ultimately come down in late 2024. Some of our lenders allow a 6-month early renewal feature, which means you can renegotiate sooner.
For the more risk averse, a longer term 2-3 year fixed rate would be ideal to help lock in rates and monthly payments. 3-year terms are currently better priced but note that they come with a significant penalty if you decide to break.
Convert to fixed. If you have a variable/adjustable rate with a short time to maturity (say, 1-2 years), consider asking about converting to a short-term fixed rate to hedge against future increases. Many lenders allow this option without a penalty or a new application to be completed.
Consider a HELOC. HELOCs are often used to fund renovations, investments and emergencies but can also carry your traditional mortgage balance. Instead of borrowing with a mortgage on a fixed or variable term, a HELOC allows you to have a fully open, interest-only option. This means that although your payments are adjustable (linked to Prime), you will only have to make minimum monthly interest payments which could allow you to increase cash flow significantly.
The next Bank of Canada announcement is scheduled for December 6, 2023.
A financial review is key to ensuring you can navigate the current climate. Let’s chat and see how we can help if we haven't already.
We’re all in this together and will come out stronger together.
Tyler Lipinski, Mortgage Agent Level 2
647.868.1427 | tyler@vinegroup.ca
555 Bloor St. E., Toronto, ON M4W 1J1
Sources:
https://www.theglobeandmail.com/business/article-bank-of-canada-interest-rate-live-october/
https://www.theglobeandmail.com/business/economy/article-canada-added-fewer-jobs-than-expected-in-october-unemployment-rises-to/
https://www.theglobeandmail.com/business/commentary/article-what-is-a-technical-recession-canada-economy/
https://tradingeconomics.com/canada/gdp-growth
https://www.theglobeandmail.com/business/economy/article-canada-added-fewer-jobs-than-expected-in-october-unemployment-rises-to/
https://tradingeconomics.com/canada/inflation-cpi
https://www.theglobeandmail.com/business/article-september-2023-inflation-canada/
https://www.scotiabank.com/ca/en/about/economics.html
https://economics.cibccm.com/#/
https://economics.td.com/ca-forecast-tables
https://economics.bmo.com/en/publications/detail/549461c1-01dc-49a0-ab9c-ef4acde56066/