The long & short of it

Michael’s dilemma. “I am faced with a mortgage renewal in six months. Help.”

So TNL@TB is offering this: five years fixed at 2.8% (although M thinks he might get a 2.6% deal). Or he can go variable at prime minus .95%. That would give him a five-year rate of 1.5% which is sexy, of course, but would change with each prime rate move.

“The discount for variable looks more substantial than I have seen it at any renewal,” he says, “so, I am actually wrestling with this decision.   I know rates are expected to go up several times in the next year or so, but that would still leave me at or below the rate of a 3 year and certainly below a fiver. What to do?”

First thing to remember is that this is free money. The inflation rate is 4.8% (in reality, much higher) and the sweet thing at the bank is offering Mike a load of cash at less than 3%. It’s an historic opportunity to build net worth, especially when so much of a low-rate mortgage payment goes to retiring principal.

So this agonizing question is really not so serious. Unless Michael bought more house that he can afford, and needs the cash flow.

Beats ne. But let’s answer the question about fixed vs VRM, given the world we are entering next Wednesday morning at 10 am Eastern time.

The latest news is not good for mortgages. This week we heard inflation continues to nudge 5%, the highest level in over twenty years. Meanwhile health officials say there are ‘glimmers of hope’ that Omigodicron is starting to crest, and will then fade. Ontario just announced Covid restrictions will be slashed in ten days.

As a result yet another bank (National) has chimed in, forecasting a rate hike next week while markets are giving 80% odds it will happen and more economists embracing the notion of six jumps by Christmas. Scotiabank predicts our CB is about to become aggressive with this agenda: a quarter-point increase next week, another in March, a half-point jump in April then three more quarter-point moves by year’s end. That’s the equivalent of seven normal hikes, and would jump the benchmark rate to 2%.

The chartered bank prime would, in this case, travel to 4.2%, and Michael’s VRM (if his bank sticks with the discount) would be 3.25% by the end of the year. More to come after that, economists say – at least another fifty basis points in 2023, following a series of hikes by the US Fed.

In short, a VRM choice would end up costing Michael bigly. From 1.5% to 3.75% or thereabouts within 24 months. Ouch. Suddenly that fixed-rate of 2.6% for five years looks a whole lot better.

Meanwhile, what will a mortgage rate eruption do to the real estate market?

Well, first remember there’s an inverse relationship between rates and prices. One up, the other down. There’s also a distinct impact on sales. A new study by the BC Real Estate Association’s chief economist (Brendan Ogmundson) quantifies the likely result. “In the past, Bank of Canada tightening has usually led to falling home sales and flattening home prices, so it wouldn’t be a surprise to see the same happening in the upcoming round of tightening,” he says.

In fact if the B0C raises its rate just five times (not the seven many others now believe) the BCREA sees sales tumbling by 25% at the end of two years. And: “If the Bank does raise its policy rate more aggressively in response to an overheating economy, then our models show that home sales would decline more significantly.”

Falling sales usually mean wilting prices. Humans being the odd animals that they are, FOMO drops like a stone when sales/prices go limp. Rather than rushing in to snap up relative housing bargains, people retreat to the sidelines and moan about it being a bad time to buy. It last happened in April of 2020, when prices took a tumble, then again in November when condo prices dropped 20% and sales evaporated.

Well, back to Mikey.

Variable-rate mortgages look cheap and history tells us that about three-quarters of the time they save borrowers money. But these days nothing’s normal. A pandemic is ending. CBs panicked, crashed rates and are now behind the curve. Inflation threatens to become structural. Debt has exploded. House prices are insane. We’re on the cusp of a tightening cycle that will last a couple of years, be intense, and yet merely take rates back to historic norms. In other words, this is not a one-and-done thing. More like ten-and-done. You may never again in your lifetime see home loans handed out like candy (or cannabis edibles) at half the rate of inflation.

Regarding VRMs, by the way, also factor in mortgage-break penalties. With a variable loan it generally costs three months’ interest to get out, while a fixed-rate loan can set you back much more since an IRD (interest rate differential) levy may be involved. So if Mike is planning on selling and moving in the next year, staying variable is a viable option. If he’s there for five years, it’s a poor one.

Six more sleeps. We’ll see.

About the picture: “Longtime reader first time caller, my wife is increasingly tired of hearing “But Garth says…” as my rebuttal to buying a home. I truly appreciate the education you provide through your blog and the work you have done in service to our country. My wife has finally worn me down and we are looking at putting an offer on a home. We are following the Garth Turner rule of 90 and buying a home we can afford both now and in 5 years. I am a very burnt out ER doc trying to find a balance between supporting my family and regaining my happiness in life. Here is our pandemic rescue, Frankie, when we got her from the humane society last spring. While she has quintupled in since she remains just as cute.”