A month ago I mused about ten-year mortgages. At the time , a tener could be had for 3.69%, which was less than half a point more than a five-year loan. You should get one, I said. A number like this shall not this way pass again.
Today five-year closed mortgages cost 5.4% (the posted rate), but are actually available for 3.69% (the real rate). Ten-year money has migrated higher to 4.29% at most of the major banks, but has shot up to 6.75% of CIBC and National Bank, where they obviously don’t want your business.
As you know, moaning, gnashing and drooling in the bond market in the past few weeks resulted in four rounds of mortgage rate increases, because that’s where fixed-rate mortgage are funded. This all started when the US Fed hinted it may end its bond-buying orgy in a few months, causing investors to pile out of fixed income, where prices had been fat and yields thin. The sell-off and the rate-pop were so dramatic that Fed boss Ben Bernanke subsequently soothed investors by saying he’s not finished stimulating yet.
But all that will change with a few more months’ worth of positive numbers out of the States. There is absolutely no doubt that stimulus spending will stop, and interest rates around the world will rise as every month takes us further away from 2008. The trip back to normalcy is as necessary as it is inevitable. People everywhere have turned into debt pigs.
There’s a direct inverse correlation between house prices and the cost of money. Real estate has risen to nosebleed levels not because people make more income (they don’t – wage gains are less than inflation), but because they qualify for more debt since rates tanked. And when interest levels stay low for long enough (this is the fourth year of ‘emergency’ rates), people start to think real estate values have hit a new, permanent plateau.
They haven’t, of course. And the next two years will shock a lot of folks who paid, say, $1.5 million for a faux baronial, stucco-and-face-stone McMansion on a 30-foot pizza slice in North Toronto. Not that they’ll face renewal in a few years and be unable to pay the going 6% rate. Instead, it’s equity the loss that’ll bite.
According to a research report from Will Dunning Inc., if mortgage rates rise just one-half point more than current levels over the next two years (an absolute slam dunk) then house sales in Toronto will decline 15% and prices will retreat 6%. Hmmm. Six per cent of $1.5 million is $90,000. Meanwhile, look at what last summer’s drop in maximum mortgage lengths, from 30 years to twenty-five, did to high-rise sales. That was the equivalent of a 0.9% rate hike, and new condo transactions have plunged by half, with construction down more than 40%.
This is more proof of what the Ottawa poohbahs have been blathering on about for the last two years – debt sits at such an astonishing level that society has virtually no capacity to absorb any rate increases. Which is too bad. Because they’re coming.
By 2015 you should budget for five-year closed mortgages to be in the 6% range, which will still be 2% below the long-term historic average. Beyond that, rates will normalize as economic growth and inflation rekindle. Sadly, the US will rebound more quickly than Canada, which means households here will get caught in the vise of slagging incomes and higher debt payments. But in a country where three-quarters of urbanites decided to become homeowners, and the average down payment is just 7%, there’s nobody fancy to blame.
Which brings me back to those ten-year loans. In a couple of years, how will a locked-in, decade-long mortgage at 4.29% look? That’s right. Like a night in Bangkok. Besides, remember that because of the Canada Interest Act, all mortgages become open after five years – which means you can keep the loan and the rate if you want, or bail out with a minimal break fee (three months) if I turn out to be a moron and rates decline.
But I doubt it. Those who argue rates will be low forever are making it up. Yes, the trip higher will be slow, but it will be relentless. The greatest threat to the economy is a credit bubble, not a real estate pop. And there’s only one certified way to stop people borrowing.
If I had a mother of a mortgage, I’d be doing two things – going long, and converting to weekly payments. But, of course, I now rent.