Nick Holloway

By Nick Holloway To a casual observer, it is fair to say that we can reflect on 2017 and 2018 as being an increasing rate environment, but now I want to take a moment to summarise where we stand up to now, and what the outlook might look like going forward given some of the latest available macro-economic figures and forecasts. The base-line to understand what is moving mortgage rates is by reviewing the Bank of Canada overnight rate, as well as government bond yields. I will look to examine some of the key features of these underlying rates and some of the reasons behind the changes we have observed. Lets start with the Bank of Canada, which started to increase, or tighten, its target for the overnight rate, also known as the key policy interest rate, from its low point of 0.5% in July 2017, with the final increase up to now during their October 2018 meeting to 1.75%. In turn, the Bank of Canada overnight rate is directly correlated to the prime lending rate which banks and lending institutions use in calculating interest payments on variable rate mortgages and lines of credit. It should be noted the Bank of Canada conducts 8 interest rate announcements each year, where the Banks committee decides whether to increase or decrease the overnight rate in line with its monetary policy objectives, and based on the last 13 meetings, we see 5 instances where the interest rate has been increased by a quarter percentage point. The Bank of Canada had indicated as part of their forward guidance, they consider a neutral nominal policy rate, which it describes as a medium to long term equilibrium concept, to be somewhere between 2.5% and 3.5%. This range is largely driven by a desire by the bank that they have spare capacity to manoeuvre should a significant downturn occur, or in other words, they have the capacity to cut, or loosen, interest rates if needed to stimulate the economy. The Bank remain cognizant that by increasing the overnight rate too quickly, there is a possibility this may act as a catalyst which causes the economy to contract, so they continue to iterate that any future increases will need to be gradual and are very much data dependant. The Bank of Canada has many aggregate data points at their disposal which they evaluate before deciding on changes to their monetary policy actions, some of which are outside the scope of this article. However, we can look at two of the main areas the Bank of Canada focuses on, being that of consumer price inflation (CPI) and real gross domestic product (GDP). Firstly, one of the banks key objectives is to keep inflation at or around 2% per annum, because it is widely accepted that the economy benefits from a small amount of inflation, whilst also looking to avoid deflationary conditions. According to the Monetary Policy Report which the Bank released following their January 2019 meeting, it confirms in Q3 2018, we saw year-over-year inflation peak at 2.7%, but this has since receded to 2.0% for Q4 2018; the projections going forward for Q4 2019 and Q4 2020 remain at the 2% target. Secondly, the Bank of Canada will consider the GDP number, expressed as a percentage, to understand if the economy is growing, as in a positive figure, or contracting, if the percentage falls below zero. For the Q4 2018 reported figures, the GDP year-over year increased by 2%, and is projected to dip slightly to 1.9% for Q4 2019 and increase for Q4 2020 to 2.1%. The report goes into more detail about some of the specific headwinds the Canadian economy is facing that may negatively affect inflation and growth going forward, noting financial market volatility, oil price declines and the slowing in growth in several key markets such as US and Europe, as well as emerging economies such as China. These headwinds might be temporary, but they are areas nevertheless the Bank is concerned about and will continue to monitor these risks on an ongoing basis. To complete our picture, we want to look at changes in government bond yields, which is one of the key driving factors behind what rates are offered on fixed rate mortgages. To provide some context based on economic theory, a government bond, or more importantly, its yield, is considered the risk-free rate of return for a given dollar amount expressed as a percentage. In a sense, it provides a yardstick for investors to determine their required rate of return in relation to the specific risk profile of a given investment. To use an example, an investor can choose to accept the rate of return from a government issued bond knowing that their investment is virtually risk free, whilst a different investor may choose to invest in a mortgage backed bond, which by its nature is considered a relatively low risk investment, however the achievable rate of return from the mortgage bond should inherently be higher than the government bond in order to compensate the investor for assuming the increase in capital risk. What we can see by looking at recent changes in the bond yields, these have increased over 2017 and 2018 period which is somewhat in-line with the changes observed in the overnight rate, with the bond yield peaking around October 2018, and has come off this high towards the tail-end of 2018. Historically, bond yields provide one of many key indicators of future inflation expectations that are effectively being priced into a tradable market. So as bond yields move higher, there is an expectation of higher inflation, which is a function of the demand by investors for an increasing rate of return, in real terms, which allows them to offset the capital erosion brought about by higher inflation. The same holds true in reverse, meaning as expectations of future inflation are decreased, the bond yields will typically respond by moving lower. So, what should we expect in 2019? That is indeed the $64 million-dollar question and it is important to recognize that some of these figures are based on projections, given it would be impossible to offer a definitive answer as to what the future holds with so many different moving parts that make up the economy. This does however help to illustrate some of the keys areas to keep an eye on in order to interpret, at least with an increased probability, what direction the economy may take going forward. As the proverb says, to be forewarned is to be forearmed.

By Nick Holloway When you are reviewing your mortgage options, it is important to understand the terms and conditions which are contained in the mortgage being offered. Within the mortgage industry in Canada, there is a wide variety of choices when it comes to selecting lenders and products. As a mortgage professional, it is an important stepto understand and review all the options available to us prior to providing lender suggestions to our clients, and then taking the time to explain all the details which are contained within the terms of the suggested mortgage. We are frequently moderating these choices for our clients based not solely on rate, but also by looking at what restrictive terms might be included within the mortgage contract. What is a No-Frills mortage? A No-Frills or Low Rate mortgage typically indicates the mortgage contract has certain restrictions which you would not typically expect to see in a standard mortgage contract. Certain examples include that full repayment of the mortgage prior to the end of term is not permitted apart from by the sale of your property in good faith to an arms length buyer, or commonly referred to as a Bona-Fide sales clause. Other restrictions which may accompany this same clause might state that once you reach the end of your initial mortgage term, you are only permitted to renew your mortgage to a new mortgage term with the same lender. As you can see, both of these clauses in place systematically restrict the borrower from securing a more competitive rate from the wider mortgage market should they so choose. What are the benefit of going with a No-Frills option? One benefit you are likely to receive is that the rate offered on your initial term is typically lower when opting for a No-Frills mortgage. To put this in perspective, you want to understand what a difference a rate reduction is going to make to what you pay on a monthly basis. So lets say we are looking at a 0.05% reduction (5 basis points) on a standard mortgage rate per $100,000 of borrowed funds, and want a quick way of understanding this change as reflected on your monthly payment. The reduction per your monthly payment in this scenario is a total of $2.64, so around the same cost of a cup of coffee. With this in mind, you can convert this figure accordingly based on the amount of borrowed funds, then multiplying by each 0.05% change in rate to ascertain the full ongoing cost increase. It can sometimes be helpful to think of what this additional cost is in the same way as how an insurance policy works, which is a premium to protect you for lifes unexpected twists and turns. Is the trade-off ever worth it? In most cases, the trade-off for being in a restrictive mortgage will typically not outweigh the rate reduction you might obtain on the initial term, however there might be specific circumstances where the benefit is sufficient to at least have some consideration assuming a full comparison is made. It is important to note that by working with a mortgage professional, we want to understand what our clients real estate goals are now and going forward. We are here to put in place for our clients a comprehensive mortgage plan which covers all your available options,and also to act as a guide afterclosing so that we may help our clients in the future. So in conclusion, if you want to pick up from the grocery store a No-Frills tin of baked beans then you do not need to give this much thought, in fact as my business professor told me once, the tin probably comes from the very same factory as the branded variety. If you want a No-Frills mortgage, always remember, Caveat Emptor. If you have any questions and want to discuss your own mortgage goals with me, please let me know, I would be happy to be your guide.