Should you lock into a fixed mortgage?

Residents of Canada are finally seeing an increase in mortgage rates for the fifth time after a long period of lower rates. This might lead you to ask if you should be locking in your rate. All three indicators of core inflation showed a 2% or higher rise last September per the Bank of Canada’s numbers.

In the subsequent October, another .25% was added to the Bank of Canada’s policy rate. The move marks five quarter-point increases for variable rate borrowers in a span of 15 months.

The preceding seven years ahead of this 15-month period featured a stationary rate. Thus, those holding variable rate mortgages are beginning to seek guidance on whether now is the time to lock a fixed mortgage rate in rather than fearing further rate hikes.

Predicting future rates is always a gamble and no one can give a solid outlook with great certainty. Precedent would indicate that the Bank of Canada will continue the recent trend of raising mortgage rates, however, it is dependent on economic security and the ability of the economy to deal with further rate hikes.

Currently, the overnight rate sits at 1.75% which is not exceedingly higher than the 0% that marked the high-point of the Great Recession. The Bank of Canada was less able to provide stimuli to the economy when the rate was 0%, as there was no further rate reduction possible. Each rate hike seen provides a buffer and room to maneuver in the event of another economic plummet.

The neutral rate estimated by The Bank of Canada is somewhere between 2.5% and 3.5%. The Bank defines a neutral rate as a policy rate “consistent with output holding at its potential level and inflation holding at target on an ongoing basis. This neutral number indicates that The Bank of Canada should continue to push onward with overnight rate raises. 

Longer periods of low to exceedingly low interest rates can also provide a fertile environment for inflation in areas not seen in core inflation reports. Real estate and other assets have been notable throughout Canada since the Great Recession. Keeping rates at levels intended as a stimulus furthers the risk of a consequential speculative bubble developing.

CPI inflation seems to be the pressing concern for The Bank of Canada in the near future. The mandate set before The Bank is to ensure the economic welfare of Canada by ensuring the maintenance of price stability – the maintenance of an overall inflation rate of 1% to 3% with a goal of maintaining a rate of 2%. The Bank uses its policy to drive the direction and maintain this ideal rate.

The Bank of Canada has voiced anticipation of the current rate dropping to near 2% through the early portion of 2019. Considerations may be made to raise the inflation rate to offset potential impacts from drops in high gas prices. Companies are having difficulty to meet the demands of their customers and unemployment is down to a historically low 6%. These factors will also put pressure on the inflation rate in the short term. This pressure is beginning to cause variable rate mortgage holders some unease and could convince them to head for a fixed mortgage in the near future.

It may behoove variable rate holders to hold off before running to obtain a fixed rate. There are other factors at work which might determine the longer-term outcomes of these rate movements.

The Bank of Canada and its decisions regarding rates impact a wide swath of areas. The Bank must know that hastiness with rate decisions and hikes that are too drastic could lead to a return to recession, create a trend of defaults on debts, or drive real estate prices down sharply. Higher rates can indeed be counterintuitive, if not handled properly, and be more impactful than higher inflation. 

The ongoing trade negotiations with the United States may be the single most influential factor in holding the Bank of Canada back from drastic policy movements. Without a NAFTA resolution, The Bank must be reserved rather than playing with the risk of calamity.

Tariffs could continue to drive pressure on inflation and encourage The Bank of Canada to continue the trend of raising rates. However, this will likely be caused by poor negotiation expectations, which would put the brakes on the growth rate of the economy and subsequently lower policy rates as time goes on.

Positive negotiations with the United States would likely lead to the Bank of Canada pressing forward quickly with raising rates. While the assessment of positive outcomes resulting from NAFTA negotiations would take time, a recession south of our border would be even more impactful on the plans to raise rates.

An unprecedented move from the United States federal government saw multiple stimulus maneuvers made in late 2017 and early 2018. A tax cut matched by new spending directed at stimulus was launched despite an economy that was operating at full capacity. This has led the U.S. Federal Reserve to struggle to keep up with inflationary pressure by quickly raising rates. 

December 2018 saw its tenth rate hike since late 2015 by the Federal Reserve, as rates were raised another .25%. These quick raises seem to be bringing about the next recession in the United States quickly and combined with the current United States budget deficit, the government will be challenged to respond with any viable policy changes. If this type of recession occurs and lasts, there is potential for it to impact Canadians after some time.

The Bank of Canada clearly wants to move forward with its plan to raise the overnight rate and appears to want to do so in the long term. However, this preference does not necessarily mean that keeping variable rates will be costly or more expensive than a fixed rate option in the long run. 

There are several reasons for the line of thinking that variable rates may not be less advantageous than fixed rate mortgages. First, The Bank of Canada continues to claim it will approach further rate hikes cautiously. The Bank also mentions that there is typically a two-year cycle for rate hikes to impact the economy. Thus, the longer The Bank takes to raise rates, the more a variable rate mortgage holder will save.

The Bank of Canada also agrees that each time the rate raises it magnifies the impact of overall household debt. Meaning, future rate hikes will likely be less as they have more and more influence each time a raise is made. Furthermore, every time rates are raised, business and export investment grow and helps prop up overall economic growth for the next cycle of rate hikes. 

While it may sound morbid to hope for a recession, and it is, comfort can be had by understanding rates will not climb during a recession. With the likely impending recession in the United States, rate cuts by United States Federal Reserve are looming, as well. This could influence a cut by The Bank of Canada, as well, and drive down rates here.

Variable rate borrowers might be comforted by this fun fact: in the last 28 years, there have been a total of zero five-year periods that variable rate holders did not see one rate cut over the five-year period. This could be a respite for the worrying minds of those thinking rates are destined to rise exponentially in the foreseeable future. The Bank of Canada’s rate hike decisions are certainly impactful but keep the previous information in mind while considering a fixed rate option.

Yes, The Bank of Canada has given every indication that rate hikes will continue for the short term, it has also said it plans to proceed with caution. The impending recession in the United States will likely impede Canadian economic growth and, in turn, provide opportunities for rate cuts down the line. It can be daunting to hold on for the ride but there are indications that variable rate holders could be saving in the future.