For years, experts have been warning about a rise in interest rates. “It could be just around the corner,” they said. “They won’t stay this low forever,” they said. And yet, as the years have gone by, interest rates have continued their steady decline. For the latest generation of borrowers, all we’ve known are these extremely low rates. But the question still sits like hovering steely grey clouds, heavy with snow: When will interest rates rise again?
A Boost for Affordability
If you’re squirreling money away in a savings account, then you may not be a big fan of the current low interest rate environment. For those looking to secure a mortgage, however, low interest rates are obviously attractive, especially for those people looking to buy a home in some of Canada’s more expensive housing markets.
Bank of Canada Governor Stephen S. Poloz recently delivered a speech to the Association des économistes québécois, the Cercle finance du Québec, and CFA Québec about the reality of the low interest rate environment in which we’re living and the consequences for both businesses and individuals of doing so.
“Young folks with mortgages regularly thank me for keeping interest rates low. When I think about how much cumulative interest I have paid in my lifetime, it is no wonder that they are grateful. But I also hear from people, especially retirees, who are unhappy because they have saved their whole lives and are getting very little income from those savings today,” Poloz said. “Ultra-low interest rates are a symptom of the conditions we face, conditions that we believe are improving over time. But some of the forces leading to low interest rates will persist for a long time, so we need to prepare for lower for longer.”
The Factors Behind Your Mortgage Rate
Variable rate mortgages are based on the Bank of Canada prime rate, and can change at any time if the prime rate changes. The advantage occurs when the prime rate drops because the interest rate on your mortgage drops as well. The five-year fixed-rate mortgage, however, has become a popular product over the years, perhaps now even more so since no one knows exactly when interest rates will rise so people want the certainty of locking in their mortgage for as long as they can.
The prime interest rate doesn’t just affect mortgages and consumer lending, however. It affects the rate at which banks borrow and lend money among themselves. So in times of economic uncertainty or slow growth, both of which Canada is currently experiencing, interest rates make it less attractive for banks – and consumers – to hold onto their money, meaning that it’s more likely that banks will loan it out or that consumers will spend it. Free moving money is thought to be a great stimulator for the economy, and raising interest rates would risk upsetting that balance.
And like timing the housing market in general, predicting the rise of interest rates is difficult because the health of the economy depends on a number of factors, including the housing market. One thing that’s certain is that interest rates aren’t going to stay this low forever. And although a handful of experts have suggested it’s possible that Canada will enter into negative interest rate territory, others claim that move would do more harm than good. And if negative interest rates never come into play, that leaves us in a kind of limbo where we know they don’t have much farther to fall, but we also don’t know how long they’ll remain at their current level before they start increasing again.
How to Plan for an Uncertain Interest Rate Future?
Since we can’t control the future of interest rates, the best we can do is plan for it.
One way to plan for an uncertain rate future if you currently hold a mortgage is to check in with your mortgage and your income every so often and perform a stress test. If interest rates rise 1% when your mortgage is up for renewal, would you be able to afford it? What about 1.5%? If you can’t, are there some things you can do between now and renewal time to free up some extra cash?
Consider Your Rate Options
If you are planning on getting a new mortgage, you may want to consider the differences between fixed-rate and variable-rate mortgages even more closely. James Robinson, a mortgage agent with Dominion Lending Centres, points out that three or four years ago there may have been a 1% different between fixed and variable mortgage interest rates, whereas now that difference is about 0.25% or less.
“The trend now is more toward fixed rates simply because – and I agree, rates are going to stay low for a very long time – however, it’s a very small gap between a fixed rate and a variable rate. So even though I think that and the minister of finance for the federal government thinks that and [Senior Vice President and Chief Economist at The Conference Board of Canada] Craig Alexander thinks that doesn’t mean it’s going to happen,” he says. “So it comes down to assessing the risk/reward and saying, ‘Well, I think this is gonna happen, but do I take that risk for 20 bucks a month? Or would I rather spend an extra 20 bucks and know that regardless of what happens with interest rates, I’m protected.’”
The Impact of New Mortgage Rules
Something else to keep in mind are the new mortgage rules effective as of October 17, 2016. While they have no bearing on whether or not interest rates themselves will rise, borrowers looking to qualify for a five-year fixed rate mortgage will have to do so at a higher rate than previously required as part of a stress test that lenders will do to ensure that borrowers could afford a rate hike.
The Bank of Canada overnight rate is at 0.5%, which means that the best case scenario for a variable rate mortgage is 0.5% less than your current rate (if we steer clear of negative rates). On the other hand, there’s no limit as to how high it could go – and although it could start going up as soon as 2017, it could also stay flat for years to come.
That route could be good for your mortgage, but when it comes to interest rates and your savings account, well . . . maybe it’s not such a bad idea to start stuffing your mattress.
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