Canadian Mortgage News
August 30, 2013
Rate Hikes and Housing: TD Research
In just a few short months, long-term mortgage rates have burst higher by almost ¾ of a percentage point.
People naturally want to know if the hikes are sustainable, and how they’ll affect the overall housing market.
TD Economics weighed in on these points in a report last week. Here’s
a quick overview of the implications TD foresees, and some observations
of our own…
- Future Rates: TD projects a 2.25 percentage point
jump in 5-year bond yields by 2017. That would peg 5-year fixed rates at
roughly 5.74%. Given economists’ poor forecasting record, this number
is a pure shot in the dark. But it’s still a worthwhile number to use
when stress testing your mortgage. That aside, one TD assertion that most would agree with is that future rate “increases are expected to be…gradual.”
- Securitization: The report notes that, “…The recently-announced changes
to the amount of mortgage backed securities that will be guaranteed by
CMHC will…lead to somewhat higher costs in funding for financial
institutions.” As we wrote on August 6th, this impact won’t be extreme for most lenders (and consumers).
- The Variable Advantage: TD concludes that even if
one assumes an abnormally high variable rate like prime + 1.00%, a
variable-rate mortgage has still “yielded a lower average interest rate
over a five year term (than a 5-year fixed) since the late 1990s.”
- The Best Rate Forward: According to TD’s analysis
and rate projections, “…Locking into a 5-year mortgage rate would yield
the lowest average interest rate over the next five years.” But TD
analyzes just four other term scenarios including a 5-year variable and
five consecutive 1-year terms. TD’s report does not touch on options
like the 4+1 strategy (i.e. choosing a 4-year fixed and renewing into a
1-year fixed). The 4+1 is a decent play today with
4-year fixed terms near 3.09% (i.e., 30 bps below most five-year fixed
offers). If you do the math, one-year rates would need to be above 4.80%
at renewal for a 5-year fixed to beat the 4+1 strategy. That’s over two
points higher than today, which makes it a good gamble given how modest
inflation and growth have been (and are projected to be).
(Source: TD Economics)
- Rate Impact on Housing: TD’s research finds that
“every 1 percentage point increase in interest rates leads to an
immediate increase in sales of 6 percentage points as buyers rush to
take advantage of lower rates, followed by a 7% decline in the months
that follow. Hence, the net impact is a 1 percentage point permanent
decline in existing home sales due to every 1 percentage point increase
in interest rates.” By our calculations that’s about 4,500 lost sales a
year per 1 point of rate hikes (based on CMHC’s sales projections). That is not catastrophic by any stretch, and frankly it seems like an underestimate, if anything.
- Income Gains: TD expects that 3-4% income growth will “help offset much of the impact of gradually rising rates”
- Mortgage Affordability: The report states,
“…Affordability using the 5-year posted rate (is) at the worst it has
been in almost 13 years. And, if 5-year interest rates were at more
normal levels of around 7%, housing would be unaffordable to the average
Canadian household.” There’s just one caveat. That statement is based
on posted rates (i.e. those rates that no one pays). “Using the 5-year
special mortgage rate, housing affordability in this country is actually
at its most favourable level since early 2000’s,” TD says. How long it
remains that way is another question. Complacency can be devastating to
one’s budget, so mortgage stress testing is once again key here.
Here is TD’s full report link
if you’d like to read more.
Rob McLister, CMT