Long-term mortgage rates have burst higher by almost ¾ of a percentage point in the short time span of a couple months!
Are these hikes are sustainable? How will they affect the overall housing market?
TD Economics weighed in on these points in a report last week. Here’s a quick overview of the implications TD foresees, and some observations of our own…
Future Rates: TD projects a 2.25 percentage point jump in 5-year bond yields by 2017. That would peg 5-year fixed rates at roughly 5.74%. Given economists’ poor track record, take this number with a grain of salt. But it’s still worthwhile to use this number when stress testing your mortgage. That aside, one TD assertion that most would agree with is that future rate “increases are expected to be…gradual.”
Securitization: The report notes that, “…The recently-announced changes to the amount of mortgage backed securities that will be guaranteed by CMHC will…lead to somewhat higher costs in funding for financial institutions.” The impact won’t be extreme for most lenders (and consumers).
The Variable Advantage: TD concludes that even if one assumes an abnormally high variable rate like prime + 1.00%, a variable-rate mortgage has still “yielded a lower average interest rate over a five year term (than a 5-year fixed) since the late 1990s.”
The Best Rate Forward: According to TD’s analysis and rate projections, “…Locking into a 5-year mortgage rate would yield the lowest average interest rate over the next five years.” But TD analyzes only four other term scenarios including. TD’s report does not touch on options like choosing a 4-year fixed and renewing into a 1-year fixed.
The 4+1 is an alright play today with 4-year fixed terms near 3.09% (i.e., 30 bps below most five-year fixed offers). One-year rates would need to be above 4.80% at renewal for a 5-year fixed to beat the 4+1 strategy. That’s over two points higher than today, so it’s a good gamble given how modest inflation and growth have been (and are projected to be).
(Source: TD Economics)
Rate Impact on Housing: TD’s research finds that “every 1 percentage point increase in interest rates leads to an immediate increase in sales of 6 percentage points as buyers rush to take advantage of lower rates, followed by a 7% decline in the months that follow. Hence, the net impact is a 1 percentage point permanent decline in existing home sales due to every 1 percentage point increase in interest rates.” That’s about 4,500 lost sales a year per 1 point of rate hikes (based on CMHC’s sales projections). That isn’t the end of the world, but it seems like an underestimate, if anything.
Income Gains: TD expects that 3-4% income growth will “help offset much of the impact of gradually rising rates”
Mortgage Affordability: The report states, “…Affordability using the 5-year posted rate (is) at the worst it has been in almost 13 years. And, if 5-year interest rates were at more normal levels of around 7%, housing would be unaffordable to the average Canadian household.” That statement is based on posted rates (i.e. those rates that no one pays). “Using the 5-year special mortgage rate, housing affordability in this country is actually at its most favourable level since early 2000’s,” TD says. How long with it remain that way? Stress-test your mortgage! Avoid Complacency.