Interest rates heading to ‘normalized’ range

Where are rates going short term (6-12 months) and long term (2-5 years)?

Both are easy questions to answer. UP! But you know that already.

Very recently, rates have crept up about .50% higher than where we were only two short months ago. Those rate increases were due to strong global economic data, much of it coming from the U.S. and European countries.

Whenever we hear of strong employment numbers being posted in the U.S. along with higher consumer confidence and higher retail sales, rates are going up – and that they did. The five-year fixed rate (which 80% of Canadians opt for and have for a mortgage) leapt up every week for a four-week period in June, finally landing in the 3.39-3.59% range.

This from a 2.89% average prior to that date, is an increase of $78/month on a $300,000 mortgage payment with a five-year fixed and a 25-year amortization. Direct interest costs to the consumer would be an average of $4,680 over the five-year term.

The funny thing is, that’s not the bad news, and it’s going to get “worse”.

As one financial expert put it, “Mortgage costs are going to from extremely cheap to just cheap.”

To put it mildly, the rooster is finally coming to roost as he’s been on holiday for five years, meaning interest rates are finally heading to the normalized range, which is 5-6% based on the 25-year average prior to the 2009 recession.

But those are in the two to five-year range, short-term, we’ll see rates rise back in to the 4% level, and there are a few factors that are going to make that happen, and it’s not just economic data, it’s the government’s plan to slow/cool the Canadian housing market values.

First is to make it more difficult for the consumer to buy a house, hence all these seemingly ‘doable’ deals collapsing, when they would have been approved only a short couple of years ago. They haven’t increased down payment rules from 5% to 10% (that’s an economy killer and they wouldn’t do that, so don’t expect it), but they are declining those seemingly worthy under the ‘guidelines’ saying they need either 10% down payment or a qualified familial co signer – that’s their way of saying a soft no.

Second – this one is more difficult to explain – but to put it simply, lenders are using up too much mortgage insurance. They aren’t only using mortgage insurance (CMHC and the like) to insurer mortgages with less than 20% down payment, they are buying up mortgage insurance on the back end to better protect themselves and their investors, and most of the lenders are doing this.

They are paying for the insurance themselves, and not charging the consumer, and this makes it easier for them to get investors on side with the mortgages as security as they are basically riskless to them (CMHC is government-backed, which means backed by Canadian Taxpayers). Apparently the government budgeted for a maximum amount of $85 billion in CMHC insured mortgages for 2013, as of end of July the lenders had insured $66 billion, and we have five months to go.

So they’ve recently set in place a maximum of $350 million for each lender. This means that lenders will have to find other sources of cheap ways to secure their mortgages, and this likely means a higher cost to them, which will be passed on to the consumer.

Ultimately we get upset every time there’s a rate increase, so the 2.89% -3.39% increases were drastic. But just wait for the fall (OR SOONER) as we’ll likely see rates increasing to the 3.7-4% range, then 3.39-3.54% will be a heck of a deal.

Best thing is to be prepared for what’s to come, as a consumer that is in the market for a home, now is the time for a pre-approval to get your rate locked in for 90-120 days as many experts are expecting rates to increase from another 20-80 bps in the short term.

Meaning as high as 4.20% for a five-year fixed, that could be the difference in qualifying for a $300,000 home today, to only qualifying for a $240,000 mortgage at the 4.2% range.

Jean-Guy Turcotte is an Accredited Mortgage Professional with Dominion Lending Centres Regional Mortgage Group in Red Deer.