Is now a good time to lock in a fixed rate mortgage?

Key Concepts

• Bank of Canada Interest Rate: Currently held steady at 2.25%.
• Variable Rate Mortgages: Constitute approximately 30% of the Canadian mortgage market.
• Bond Yields (5-year & 10-year): Used as benchmarks for fixed mortgage rates.
• Mortgage Spread: The difference between mortgage rates and corresponding bond yields (currently around 1%).
• Mortgage Default Rates: Increasing, currently at 24 basis points, with expectations to reach 32-34 basis points.
• Housing Prices: Declining in Ontario, nearing 2019 levels, with Ottawa remaining relatively strong.
• Neutral Rate: The Bank of Canada considers 2.25% to be the bottom of its neutral rate.

Bank of Canada Holds Steady, Mortgage Market Analysis & Housing Trends

Interest Rate Decision & Inflation/Unemployment Data

The Bank of Canada has maintained its key interest rate at 2.25%. This decision follows a marginal increase in inflation coupled with a rise in unemployment figures in December. Policy makers previously indicated in October that current borrowing costs are appropriately positioned to support economic growth while maintaining inflation near the 2% target. The Federal Reserve is also scheduled to announce its interest rate decision later in the day.

Impact on Variable Rate Mortgages

The Bank of Canada’s decision is considered disappointing for Canadians holding variable rate mortgages and Home Equity Lines of Credit (HELOCs), as these are typically tied to the Bank of Canada’s interest rate policy and the prime rate. Ron Butler, a mortgage broker at Butler Mortgage, estimates that variable rate mortgages currently represent approximately 30% of the total mortgage market. Variable rate holders had hoped for rate cuts, but those did not materialize. Rates have already decreased significantly in 2024 and 2025, falling by 50% from their 2023 highs.

Bank of Canada’s Perspective on Variable Rates

According to Butler, the Bank of Canada views the impact on variable rate holders as a secondary consideration. The Bank believes it has already effectively lowered rates for this group, and 2.25% is considered the bottom of its neutral rate range. Tiff Macklem, the Bank of Canada Governor, initiated a pause in rate increases in November, which continues to be in effect.

Fixed vs. Variable Rate Considerations

Butler suggests that individuals might consider locking in a fixed mortgage rate. Currently, five-year fixed rates are hovering around 4%, with some deals available at 3.89% or 4.19%. These rates are largely influenced by the 5-year and 10-year Canadian bond yields.

Bond Yield Volatility & Market Uncertainty

Butler emphasizes the current volatility in the financial world and geopolitics, making accurate predictions difficult. He notes that the Japanese bond market is now a point of consideration for mortgage professionals, highlighting the unusual global economic climate. Currently, the government could issue new five-year bonds at just under 3%, while a five-year mortgage costs approximately 4%, representing a 1% spread.

Mortgage Spreads & Bank Competitiveness

The spread between mortgage rates and bond yields has narrowed over the past five to six years. Historically, banks sought a spread of around 1.25%, but are now comfortable with a 1% spread due to increased competition. Butler points out that despite Canada having fewer banks than the US, the Canadian banking sector is highly competitive in the mortgage market. He recalls a time when mortgage funds (mutual funds offering mortgages) were common, but banks eliminated them due to their profitability, preferring to retain the business themselves.

Rising Mortgage Default Rates & Housing Market Conditions

Mortgage default rates have been increasing. In 2021, 90-day default rates were at a low of 12 basis points, but have risen to 24 basis points, with expectations of reaching 32-34 basis points in the next year. The real estate market in Ontario and British Columbia is facing challenges, with home values declining. This decline affects not just condos, but the broader housing market. House prices in Ontario are nearing 2019 levels, representing a significant reversal from the 2021 peak. Ottawa’s housing market remains comparatively strong.

Government Affordability & Home Value Concerns

The federal government has faced criticism for its ambiguous stance on housing affordability, with the Housing Minister, Gregor Robertson, stating the goal is to achieve affordability while also maintaining home values for Canadians.

Political Implications of Falling Home Prices

Butler believes that falling home prices are unlikely to significantly impact the Ontario Conservatives in future elections, as the public generally understands that the provincial government has limited control over housing prices. However, it will likely contribute to overall financial dissatisfaction among Ontario residents.

Technical Terms & Definitions:

• Basis Points: A unit of measurement used in finance to describe the percentage change in an interest rate or yield. One basis point equals 0.01%.
• Prime Rate: The interest rate that commercial banks charge their most creditworthy customers. Mortgage rates are often linked to the prime rate.
• Bond Yield: The return an investor receives on a bond. Used as a benchmark for mortgage rates.
• HELOC (Home Equity Line of Credit): A line of credit secured by the equity in a homeowner's property.
• Neutral Rate: The interest rate that neither stimulates nor restricts economic growth.

Logical Connections:

The discussion flows logically from the Bank of Canada’s interest rate decision to its impact on the mortgage market, specifically variable rate mortgages. This then leads to a broader analysis of fixed vs. variable rate considerations, bond yields, and the overall health of the housing market. The conversation also touches upon the political implications of housing affordability and the government’s response.

Data & Statistics:

• Bank of Canada Key Interest Rate: 2.25%
• Variable Rate Mortgage Market Share: 30%
• Mortgage Default Rate (2021): 12 basis points
• Mortgage Default Rate (Current): 24 basis points
• Expected Mortgage Default Rate: 32-34 basis points
• Mortgage Spread (Historical): 1.25%
• Mortgage Spread (Current): 1%

Conclusion:

The Bank of Canada’s decision to hold interest rates steady has implications for both variable and fixed rate mortgage holders. While variable rate borrowers may be disappointed, the Bank believes it has already taken sufficient action to lower rates for this group. The current economic climate is volatile, and the housing market is experiencing a correction, particularly in Ontario and British Columbia. Navigating this environment requires careful consideration of fixed vs. variable rate options and an understanding of the interplay between bond yields, mortgage spreads, and overall economic conditions.