The Incredible Shrinking Mortgage Rate

May 8, 2013 Tim Shufelt

When the Bank of Montreal dropped its key mortgage rate below the 3% threshold in March, Paula

Roberts started to get calls from her clients. They wanted to know if they should break their mortgages

and refinance at BMO’s limited-time, bargain-basement 2.99% rate—the lowest rate ever officially offered

by a Canadian bank for a five-year, fixed-rate mortgage. The sudden surge in interest baffled the Toronto

mortgage broker. After all, these were clients who were already locked into mortgages with even lower

rates and better terms than BMO’s. “All of our lenders were at lower than 2.99% at that point,” Roberts

said.

It’s an open secret that Canadian homebuyers can secure mortgages on the cheap these days. BMO

simply advertised the kind of lending practices that were already widespread. But stating the obvious got

the bank plenty of attention—from media, from Canadian borrowers and from the federal government.

Finance Minister Jim Flaherty also picked up the phone, calling BMO to register his disapproval of the

rate reduction. “My expectation is that banks will engage in prudent lending—not the type of ‘race to the

the average discounted rate on five-year mortgages over the past five years, which according to

ratehub.ca is about 4.25%, Shearer will have saved about $18,000 in interest and owe $6,000 less by the

time his mortgage expires. Compared to the 6% peak five-year rate over the past five years, Shearer will

save more than $50,000.

While Shearer wasn’t compelled to buy real estate by low mortgage rates alone, they were an added

incentive that made the market more attractive to him. This runs counter to the government’s deliberate

attempt to contain housing activity. Bank of Canada governor Mark Carney warned of a “brutal reckoning”

when rates eventually climb and expose the finances of many households as unsustainable. There are

those homeowners who can afford a $700,000 home today, but could only afford a $500,000 home at

6.5%, which is where rates could conceivably sit in five years when new mortgages expire, says John

Andrew, a real estate professor at Queen’s University.

says Ohad Lederer, a financial services analyst at Veritas Investment Research. That would put a floor

on five-year mortgage rates of about 2.6%—assuming the five-year bond rate doesn’t fall any further.

Variable or shorter-term mortgages are already available for even less. So yes, there’s still room for rates

to fall, and banks may prove willing to sacrifice profitability for market share. “You’re talking about a longterm

customer. The vast majority of mortgage borrowers are on a 25-year amortization period, and if

they’re with a major lender, they will probably never leave,” Andrew says. “It also opens up other

opportunities. Once you’ve got a relationship with a lender, maybe you’re more likely to get a savings

account, get a line of credit, or take another mortgage out.”

To Flaherty, the competitive strains of the market do not justify a mortgage rate war in the banking sector.

But it’s unusual for a finance minister to publicly scold a financial institution like Manulife for a pricing

decision. “The whole thing is puzzling,” Andrew says. “It’s like phoning up Galen Weston and saying I

don’t like the price of milk.”

Criticism came from many quarters, including the Conservative party’s own ranks. “Me, personally, I

would not dictate to businesses what prices to decide,” Small Business Minister Maxime Bernier said. “It’s

the market. It’s supply and demand that decides the prices. It is the case for interest rates; it is the case

for other products too.”

The Canadian mortgage market, however, is not exactly free and open. The Canada Mortgage and

Housing Corp. insures roughly half of outstanding mortgages in Canada against default. Genworth

Canada, backed by a federal guarantee, covers another 25%. So for the great majority of the Canadian

mortgage market, the risk of default is shouldered not by the banks, but by taxpayers. “For the banks, it’s

fantastic,” Andrew says. “They get their money and they don’t have any of the hassle of the foreclosure

process. It’s pretty much an ironclad guarantee.”

Whereas default risk is a natural disincentive to loose lending, from the banks’ perspective, the risk of

issuing mortgages is minimal, which helps to explain why they’re willing to loan money at such low

margins. It also helps to explain why the government wants to have a say in how mortgages are priced.

“The more people take on debt, the bigger the contingent liability the government has, the riskier it gets,”

Routledge says.

Of course, the government can always tighten regulations to effectively limit the availability of mortgages.

While he has no control over mortgage rates, Flaherty does have the power to further reduce the

maximum amortization or increase the minimum down payment on insured mortgages. But there are

competing concerns emerging about the Canadian economy, aside from housing, and Flaherty has given

no indication he intends to resort to further regulation. Mortgage tightening effectively pushes marginal

borrowers out of the market, reducing the size of the pool of first-time homebuyers. And it’s that cohort

driving much of the demand for condos and suburban starter homes, Andrew says. The government can’t

afford to unduly impair the construction sector. Rather, it wants to slowly let some air out of the housing

bubble without triggering anything severe.

Given all of that, the big question is whether rates will sag even lower in the months and years to come. It

could indeed happen if the Bank of Canada keeps the overnight rate where it is right now, while a slowing

housing market puts even more pressure on the banks to cut their profits as they battle for share in a

dwindling market.

As for the first condition, outgoing governor Mark Carney announced on April 17 that the Bank of Canada

was yet again keeping its overnight rate at 1% and said the bank was pushing back its own projections for

the economy’s recovery to “full capacity” to mid-2015. “This is later than was anticipated by the Bank in

January,” Carney said. In other words, the target interest rate looks likely to remain at its current rock

bottom through 2014—and perhaps even longer.

The second condition for declining rates will likely be satisfied too: housing unit sales have now been

declining for months, unemployment has remained stubbornly high, and economic growth is still sluggish.

All these factors further constrict the number of mortgage-worthy homebuyers; as banks scramble to court

them, cutting into their profit margins looks ever more likely. That could conceivably take variable rates as

low as 2.2%—perhaps even lower.

For the moment, Manulife and BMO have fallen back in line by reducing the visibility of their mortgage

rates. But nothing has changed in terms of the mortgage contracts being signed. Roberts, the Toronto

mortgage broker, is advising all of her existing clients that if they are currently locked in mortgages at

rates of 3.59% or higher, they need to consider breaking their contracts and refinancing, depending on

the penalties and time to maturity. The lure of a bargain is hard to resist, and it looks like more bargains

are on the way—just don’t tell the finance minister.

Source: Bank of Canada