Happy New Year!
As we start off the new year many people are concerned about their finances and how inflation will impact their lifestyle going forward.
Higher prices are affecting food, gas, entertainment, and interest rates. For those with mortgages due for renewal in 2023, higher interest rates will impact them significantly.
Homeowners are asking me what they should do with their renewals. Homeowners are asking me about their renewals and whether or not now is the time to refinance. Buyers are asking me about the best term to take on a new mortgage.
Is locking in the current rate for a shorter period of time the best approach? Or is it better to ride out the highest variable rates we’ve seen in 15 years?
The environment of the real estate industry at the outset of 2022 was one of ultra-low interest rates and unconditional offers. By the end of 2022 unconditional offers were unheard of, interest rates more than doubled, and home prices in most regions across the country dropped. With such a rapid change in the real estate market, people who are buying and selling homes now or in the near future are trying to figure out what could be next.
I don’t have a crystal ball, but as an industry expert I can share some thoughts and insights.
In the heat of the market in late 2020-21, it was common to purchase a home for up to $200K over the asking price with no conditions and financing at a 2% interest rate. A fear of missing out coupled with a growing demand for homes that would accommodate a work-from-home lifestyle due to the pandemic caused home prices to rise weekly. The ultra-low rates fueled this demand.
In today’s market, you can purchase a home at or below the asking price, with time to get a home inspection, and financing conditions satisfied at around 5% interest. This is better than paying $200k over the asking price even at 2% interest.
Additionally, these higher rates are not going to last forever. No one knows with certainty how long it will take to bring inflation back down into the target 2-3% the federal government is aiming for, but some economists are predicting it could take one to two years.
Why? Let me explain.
The tightening cycle, which the Bank of Canada embarked on last March, is the most aggressive we have seen since the early eighties. However, because of market evidence, mortgage investors are predicting a drop in interest rates in the next 1-2 years. This is observable in the bond market where we price fixed interest rates.
The yield curve, a graph that depicts the amount of interest paid by various bonds, is severely inverted as we head into 2023. In a healthy economy with normal inflation rates, the yield paid by bonds increases with length of time–five and ten year bonds normally yield more than two year bonds. In an inverted yield curve the bond market’s short-term rates are higher than long-term rates. This means that a two year treasury note offers a higher return than a five year note. A yield curve inversion and the bond rates that come with it can upend the bond market and may portend worse economic conditions to come.
The inversion today is signaling that investors and economists are pessimistic about long term economic growth which means they are seeing the economy slowing significantly in the coming months. When the economy slows, inflation will start to drop. Eventually, this will bring interest rates down–likely to pre-covid levels.
These market conditions could mean a few things for your mortgage. If you want to know what your mortgage payment is going to be for the next few years, I would suggest you consider a shorter-term fixed rate of two to three years. Alternatively, if you can handle the stress of not knowing how high the Bank of Canada may raise the overnight lending rate, a variable rate can be locked into a fixed rate at any time.
Getting advice from a range of economic advisors is a great way to make an informed decision.
I advise those in the market to reach out to a mortgage expert, preferably one that is not tied to any particular institution. Additionally, it’s a good idea to also speak with your investment advisor and your accountant.