Senior Deputy Governor says lower rates are the new normal.

 In her first public speech as Senior Deputy Governor for the Bank of Canada, Carolyn Wilkins brought some good news to Canadians with mortgages.    Interest rates should remain low for some time….. and we can expect lower rates to be the “new normal”.

Ms. Wilkins went on to say that “the recovery has had repeated false starts and still faces considerable headwinds.”  This seems to be the new message coming from the Bank of Canada.  And I must say, it’s a refreshing change from the previous high-profile Governor, Mark Carney.

UNPOPULAR COMMENTS

Remember our previous Bank of Canada governor?  Mr. Carney earned high praise for helping Canada avoid any U.S. style recession.   But in the years leading up to his 2013 departure, his repeated warnings of pending interest rate hikes never materialized.  In fact, we now know they were way off.  Interest rates went down and have stayed down.    Looking back, Carney’s rate hike warnings sounded more like ‘the boy who cried wolf’.

BANK OF CANADA NEW NEUTRAL RATE AND UNDERSTANDING WHAT IT MEANS.

Ms. Wilkins gave us a lot of info to digest in this speech and I think we need to pay some attention to this..  One of the more popular catch phrases that made headlines is “Neutral Rate”.   A neutral rate is where our Bank of Canada interest rate should be when our economy is running at full capacity (if it ever does again) and with modest inflation.

Follow me here for a minute while I decipher what this means…. You’ll be hearing more about ‘neutral rate’ in the coming months so let’s understand it…

For the past several years, the accepted neutral rate was considered to be in the 4.5% to 5.5% range.  Ms. Wilkins said we should expect the new neutral rate to be 3% to 4%.   That’s 1% to 2% lower than what economists previously expected.  This means that even our Bank of Canada is calling for maximum rate increases.

This translates to a Bank Prime rate of between 5.50% and 6.50%.  BUT WAIT…  For those in a Variable rate mortgage, this doesn’t mean your mortgage rate will go to 6.00%. This is where the Bank of Canada is expecting the neutral rate to be IF and when the economy is running at full capacity.    And no one believes that will happen anytime soon.

INTEREST RATE INSURANCE AND PROTECTION AGAINST HIGHER RATES.

We all want the security of knowing what our mortgage rate will be for years to come.  Call it the ‘Canadian way’.  But the reality is that this kind of rate security comes at a price.  It means you need to choose a fixed rate for an extended period of time…  And fixed rates are typically 1.00% to 2.00% higher than Variable rates.  Hey, when you repeatedly keep hearing and reading that mortgage rates are going up, it’s hard not get alarmed and choose a fixed rate…

For some of us, choosing a fixed rate makes sense…. first time homebuyers or those with a tight budget almost have to choose a fixed rate.   But for the rest of us, we need to look at historical rates, future rate outlooks and our own personal situation.  If you can stomach some rate movement, then consider Variable rate.   It’s proven to be the lowest cost mortgage option.

DON’T FORGET INFLATED PENALTIES

My regular readers have heard me talk about INFLATED PENALTIES  charged by the BIG SIX BANKS many times…  We’ve seen hundreds of consumers get hit with penalties of $20,000, $30,000, $40,000 and higher.  These numbers are real!   Please beware of these costs… The BIG SIX BANKS use an inflated prepayment penalty calculation.  YOU can easily avoid this.  There are other lenders out there…  better terms, fair penalties and almost always better interest rates…look for other options.. they exist and are easily found…!

QUICK REVIEW OF THE LAST 10 YEARS OF INTEREST RATES.

I did a quick search of historical rates and found these stats on the Bank of Canada website.

Of course, we all know that no one pays posted mortgage rates.   So let’s discount the 5 yr fixed rate by 1.75% (that probably much higher than the average discount over the last 10 yrs but let’s do it).  We get an average rate of 4.17%.   Now let’s reduce the Bank Prime rate by 0.75% to give us our average Variable rate.  We get an average Variable rate of 3.09%.

Compare the two rates and the average Variable rate consumer saved 1.08% on their mortgage every year for the last 10 yrs!    On a $400,000 mortgage, this works out to a $38,902 savings.   Or $324/mth.   Not bad.    For many consumers, the cost of choosing a Fixed rate was much greater because of inflated penalties or poor timing of choosing a fixed rate..

Your best interest is my only interest.   I reply to all questions and I welcome your comments.  Like this article?  Share with a friend.

Steve Garganis 416 224 0114 steve@mortgagenow.ca