The gap

Folks have started gambling again.

Brokers report a ton more interest in VRMs – variable-rate mortgages – now that everybody believes rates have climaxed and will soon go limp. There was even a story on my questionable online news feed today with a headline asking, “Is the five-year fixed mortgage dead?”.

Now a VRM, as you know, floats with the prime. When rates erode, prime will move immediately taking the cost of mortgage with it. Most economists are still calling for three reductions by the end of 2024, which would make a variable rate close to 1% cheaper by Christmas, if that came true.

But remember that variable-loans creamed a lot of borrowers who gobbled up cheap debt in the months following the pandemic. Their 1.5% or 2% loans with static monthly payments turned against them when the Bank of Canada embarked on its aggressive tightening campaign. Those fixed payments shielded family cash flow but eventually didn’t even cover the interest on the loans. So amortizations went nuts (forty to 70 years) with unpaid interest added to the outstanding debt. And now folks face painful renewals.

But here we are on the other side of the mountain, many feel. With rate cuts in the air, more borrowers this spring are willing to gamble that over the next few years floating-rate loans wil win – a pattern history supports.

For context, these days a five-year fixed can be had for just a touch over 5% at most of the banks. A variable loan is currently priced at 6.7%. The spread is huge, and so is the gamble. Does this make sense?

We’ll see. But sentiment is growing that fixed mortgage rates are actually about to increase. This comes after recent data showing consumer and producer prices in the States have inched higher, and in advance of the next inflation report in the land of maple. There has been an impact on bond yields, as you can see here with benchmark five-year Canada debt.

Bond yields tick up. Mortgage rates next?

Says mortgage broker blogger, celebrity and social media influencer Rob McLister: “Strong macro data are hoisting bond yields. Our 5-year bond’s line in the sand is ~3.85%. Cross that, and we’ll probably have to brace for a hike in fixed rates.”

Hmmm.

So what is Mr. Market now saying?

Odds of a quarter-point rate cut by the US Fed in June are sitting at roughly 50-50. For the end of July chances of a drop (at least 25 beeps) rise to 73%. By September, the possibility of rates being at least a half point less is 60%. By the end of 2024, the betting is 62% that the cost of money will be three-quarters to a full 1% below current levels.

As for Canada, our CB follows the Fed 91% of the time. Moreover, our economy is a lot weaker than that of the States (even with a crazy presidential election going on) so a bunch of smart people think rates here may actually fall sooner and perhaps further than those in America.

The consensus hasn’t changed much, despite steamier data. Three cuts by Christmas. The tightening is over. There’ll be no increases. Yet central bankers are totally aware that real estate should not be allowed to erupt again.

So, should you go variable, knowing cheaper money is coming? What if Trump wins the White House again, does to the Fed what he did to the Supreme Court, forces rates down and tries to inflate away debt? Is it worth gambling?

At 1.7% these days, the spread between fixed and variable is wide. VRM borrowers may end up paying a premium for years before they emerge victorious. Besides, how bad is a 5% mortgage over five years? Could that, plus a 7%+ stress test, not keep some kind of a lid on real estate prices? Is this really a cruel rate when the long-term average is 7%? When Dorothy and I got our first mortgage it was 12%. When I was elected an MP a mortgage was 14%. As a newspaper business columnist, I documented 21% home loans.

Then the cheaper money became, the more bizarre house prices turned.

Soon rates will decline again. In a world rife with elections, populism, pissy voters and unfulfilled house lust there’s no telling where this pendulum will swing.

But, whatever happens, this seems obvious: if you can’t afford a house at five per cent, don’t even try.

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