The Bank of Canada Rate Drop and Your Mortgage

By Garth Chapman

So you’ve no doubt heard about the recent Bank of Canada overnight target rate drop. In an effort to stimulate the slowing Canadian economy, the Bank has lowered their rates by a quarter of one percentage point to 0.75 percent.  

Before you panic about what this means for you as an investor, remember that all markets tend to overshoot – financial, bond, stock, and real estate.  Yes, this news is likely a bit stressful but it doesn’t mean that you need to put an abrupt stop to your spending or borrowing.

So why is this happening and what does it mean for fixed-rate and variable mortgages?

Canadian banks are operating under more regulatory oversight than ever before as well as adjusting to a bit of a financial hangover after an all-out enjoyable party. The Bank of Canada and the Canadian federal government have been warning consumers to reign in their borrowing which begs the question, what will happen now? Will consumers follow suit? I also can’t help but wonder whether or not banks will a) tighten up liquidity (lending to businesses) or b) tighten up liquidity (lending) to consumers.

The Impact on Fixed Rate Mortgages

I predict that fixed rates will come down more yet in the coming weeks and months since Minister of Finance Joe Oliver will not be as likely to intervene as his predecessor (Jim Flaherty) was. Current stats show a 5-year benchmark bond yield of 0.61 (as of January 30^th) or a 2.1% spread between the Bank of Canada overnight rates. Historically, the norm has been lower – in 2003 the spread was 1.3%, in 2006-2007 it went as low as 1.0%, and in 2008 it went to between 1.5 and 1.7%.

The Impact on Variable Rate Mortgages

With the overnight rate now down to 0.75% due to Bank of Canada concerns about the Canadian economy, it has become the theoretical source of variable rate mortgage (VRM) funds to lend in VRM markets. With variable discounts at 0.70% off prime, the rate to consumers is 2.15% and the spread is 1.40%. But, on the other hand as the process becomes complex, and they lend on an 18 to 1 multiple of assets, it will become more difficult to tell what the true spread is.

So, what do I think will happen next?

First, banks will continue to work very hard to maximize margins in this new world of lower lending growth.

Second, I don’t think they will be eager to increase discounts to prime rates or to pass on the full overnight rate reductions that are likely to come. 

Third, rates will remain low for the foreseeable future – this is the new normal. With the USA economy back in gear, when the US raises interest rates it will put pressure on the Canadian dollar as will the relative number of savers and borrowers and the size of their need.  Both factors will have a determinative impact on the market for loanable funds. On that note, I expect the Canadian dollar to remain below .80 cents US for an extended period which will push inflation against the downward flow of other factors. I don’t except deflation to be a concern in the near or midterm.

Fourth, retirees are in for one to two decades of much lower than excepted income from their investments. This is a big issue that may prove difficult to solve as baby boomers chase security instead of return, causing distorted long-term rates (in part due to huge bond deposits).

As with any projection, things can quickly go awry. In the case of mortgage rates, if a significant war involving at least one major power on each side occurs, it could make these projections go completely out the window.

We will just all have to stay attuned to what the market is doing and not make any rash investments decisions without having all the facts.

Garth Chapman is a REIN member and mortgage advisor with Jencor Mortgage Corporation. Garth has over a decade of real estate investment experience and has completed a wide range of projects including over 60 flips, several condo conversions, renovation projects, land subdivision, lease-options and agreements-for-sale, and of course continues to hold several rental properties.  

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