Dispelling the Fear About Rising Mortgage Rates

20 June 2012

The experts, led by the Bank of Canada, have been telling the public that when interest rates rise by 2or 3%, we will all be losing our real estate properties. But before we jump off that bridge we need to look at what the interest rate market is telling us about future rates. Borrowers have a choice between fixed and variable rate mortgages. Fixed rate mortgages are based on the bond market – the cost of funds. A great way to predict future interest rates is through the yield curve. The yield curve shows interest rates of the same risk class with different terms. Let’s look at today’s market: you can get a two year mortgage for 2.85%, a five year for 3.09% and a ten year for 3.79%. In the simplest terms, lenders are comfortable at lending at either five or ten years. Everything being equal, lenders believe five year rates will be 4.49% in five years from now. That is what the yield curve is showing. And that would be an increase of 1.4% over five years. Surely the real estate market and home owners can cope with that. Who expects their incomes to increase by only 1.4% over five years? No one who is working!! Variable rates are based on bank prime – currently at 3%. The Bank of Canada rate is 1%. The yield curve for Bank of Canada borrowings is 1.16% for two years and 1.87% for ten years. The Bank of Canada is well aware that if they raise their prime rate to 2% they will create a negative yield curve and the greater the negative difference between short and long, the higher the probabIlility of a recession and the worse the recession will be! So why would the Bank of Canada do this? And if they were foolish enough to take the risk, at most they would raise rates by 1%! That’s why the Bank of Canada is left with only using rhetoric, carried by the Media to warn Canadians about the fear of rising interest rates jeopardizing home ownership.