Central banks around the world have slashed their benchmark interest rates to pretty much zero in an attempt to stimulate the economy by making it as easy as possible to borrow, spend and invest.
However, in Canada’s mortgage market: rates aren’t going down by as much as they should be. In some cases, they’re actually rising.
Mortgage rates tend to move up and down based on a number of factors, but one of the main ones is the costs borne by the lenders themselves.
People tend to think that when someone walks into a bank to ask for a home loan, if they are approved, the bank just takes the cash out of some safe at the back, hands it over to the borrower and charges them interest over time to make a profit.
Except, banks don’t keep that much money just lying around either — they typically borrow it themselves and make money on the spread between how much they’re charged for it and how much they turn around and charge the borrower for it.
Fear driving rate cuts:
The cost of financing a variable rate loan is strongly influenced by the Bank of Canada’s benchmark rate, because banks tend to set their own prime lending rates based on whatever the central bank’s rate is.
The bank has cut that rate by 150 basis points — 1.5 percentage points — in the past month to try to make it as easy and cheap as possible for people to borrow, spend and invest to stimulate the economy that has been waylaid by COVID-19.
A few short weeks ago, it wasn’t hard to find a variable rate mortgage for something around prime minus one — a full percentage point below whatever a bank’s prime lending rate was at the time.
Since then, however, Prime lending rates have gone down more or less with the Bank of Canada’s moves, but those discount rates for mortgages have disappeared.
The reason they’re doing that is the same as why stock markets plunged, and governments rushed to implement lockdowns on millions of people: fear.
Bond yields are the biggest factor that goes into setting rates for fixed-rate mortgages, and they have plunged to almost their lowest levels on record in recent weeks.
Banks building in higher risk:
When the economic outlook was clearer, banks were happy to cut rates as low as possible to try to consume market share. But now, they’re saying, “We better earn a bit more of a spread on this money because these things might default at a higher rate than we’re used to.”
The impact isn’t dramatic. A few weeks ago, the best mortgage rates were something in the range of between two and 2.5 per cent. Today, they’re between 2.5 and three per cent because they are demanding a higher risk premium than what they typically do.
Lastly, the overwhelming majority of first-time buyers prefer fixed-rate loans because they like the security of knowing that their monthly payment is guaranteed to not increase. The banks know this, and it might soon have a heavy cost for borrowers.
COVID-19 recession on horizon:
The current situation can’t last forever. Economists are already predicting that the COVID-19 recession is likely to be incredibly sharp, but it’s anyone’s guess how long it will go on for. The best sign that things are getting back to normal will be when the big banks start to act in a way that seems inconsistent.
Banks are raising their rates right now because they feel just as uncertain about the future as Canadians do. Once that cloud lifts, they’ll want to start lowering rates again and they won’t build in that uncertainty premium like they are now.
As confidence returns, you’ll see rates fall.
For all of your mortgage questions, broker Kevin Decker can be reached after at 250 619 2262 and broker Jason Barudin can be reached at 250 668 2203.
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