Rates have been at an all-time low for the past six months but my crystal ball predicts a sharp hike coming our way in the near future. At the start of the Pandemic back in March 2020, if you recall, we had seen a spike in interest rates which seemed counterintuitive for many. At that time, as we were going through a “forced” recession by governments, rates were skyrocketing rather than dropping and many could not understand why. The reason this occurred was because of what was happening in the Canadian Mortgage Bond market.
Let me first explain how and why bond rates fluctuate. If you have a high demand for a bond then the price of that bond will fall, however, if you have a low demand for a bond the price will go up. Here is an example to illustrate: Let’s assume I issue bonds to raise capital for my company. If I have a lot of demands for that bond, then the price of that bond would actually drop, but if however, I have very few people willing to buy that bond, I would have to increase the return offered on that bond in order to attract more buyers. Now you can see why there is an inverse relationship between the demand for the mortgage bonds and the way that interest rates fluctuate. If you have no buyers, the return on investment will continue to go up until someone buys, thus increasing the cost of borrowing for the banks when it comes to the fixed-rate mortgages.
In March of this year we saw rates climb and all of a sudden drop really fast. Why did this happen? Why did we see this drop occur in rates if demand on the bonds was low? Based on the supply and demand for those bonds, rates should have increased rather than drop. This happened because of what our government did behind the scenes. You see the Bank of Canada bought out all of the mortgage-backed securities and created liquidity in the market thereby allowing for cheap money to flow.
How much did they buy? The BoC purchased over $9.3B as of the first week of October. If we compare it to last year’s acquisitions that the BoC did, it represents an increase of over 1,700%. That amount of investment into the bond market created the effect of these historically low mortgage rates, and this BoC spending spree is now coming to an end.
By the end of October 2020, BoC is said to stop buying bonds, and once this occurs, we will see rates on these bonds start to climb as they try and find a new footing to rest on. My prediction is that before the year is over, we will see mortgage rates climb to the same level they were pre-pandemic. If the trend continues into next year, we could see the rates increase, in the start of 2021, to around 3.5% to 4% for a standard five years fixed mortgage.
So what is your next move? If you currently have a fixed-rate mortgage that is higher than 2.6%, it might be a good idea to look at an early renewal, in order to secure a lower interest rate. This is also a great time to look at options for refinancing if you need some extra liquidity to pay off debts or renovations. If you are currently on a variable rate mortgage, you can probably ride out the next couple of years without seeing any increase in your rate seeing as variable rates are not affected by the bond market but rather is a rate based on a discount off the Prime Rate. However, if you’re carrying a variable rate with a discount of anything less than .60bps off of prime, it would be a good idea to look at converting that variable to a fixed rate.
When it comes to your mortgage, being informed is key and knowing what type of rate you have and the cost versus benefit of renegotiating that mortgage is crucial. Armed with the right information in hand, we can all make educated decisions and properly prepare for 2021.