October 26 Bank of Canada Rate Announcement Recap

Introduction: Think today's mortgage process is complicated and stressful. You're right, it is, but it doesn't have to be. Nice. This is the House Rich Podcast and we've simplified the mortgage process. Your host, Matt Parker, AKA Mortgage Matt, delivers practical advice in a fun and entertaining way to help you understand your mortgage so that you can start making money, not the bank. So let's get your home ownership journey started. Here's your host, Matt Parker.

Matt Parker: Hey Matt Parker here. If you're joining live, fantastic. If you're watching this later on, just as good. I hope this information today is helpful, relevant and gives some insights and guides you through obviously some challenging months and some potentially challenging months ahead because there are some big changes happening. So today the Bank of Canada announced a half a percent increase in their overnight lending rates. So that's 50 basis points, so 0.5%. So what does that mean? It's pretty much on par with some experts analysis on what may happen. Some were thinking even higher, three quarters of a percent. So a little bit less than certain economists thought. I was at the National Mortgage Conference for the Canadian Mortgage Professionals a few weekends ago and there was a lender panel with executives. There was a very well known economist speaking, Benjamin Tal, and everyone was a bit divided on what we might see in terms of interest rate increase, but everyone was very much on the same thinking around what's going to happen going forward in terms of rates.

And it was definitely going to continue to go up. Primarily because, which we'll talk about later as well, is the Bank of Canada has said that they much prefer from their words a recession than inflation. So right now what they're trying to focus on is they're trying to get inflation back down to their target range, which is that 2% range. So difficult part about that is the actual impact on homeowners/consumers is significant for them to enact economic policy, which in theory probably makes sense. But the true impact on you, me, anyone in a mortgage, whether it's fixed or variable because a lot of fixed rate clients are hitting renewal with a significantly higher interest rate. Everyone's affected by the rising interest rates. So we have to take a step back and just sort of look at the inflation problem. Now I'm first to say I'm not an economist, but I do have a lot of good data that has been provided to me that I hope sheds some light on really what's happening and what's driving things instead of maybe the confusion out there.

So really if you split it up, there's two parts. So about half of the inflation problem would be a supply chain issue, which was pretty much created from the pandemic because a lack of production supply, and then also just a change in spending from service based spending from consumers to pretty much all goods related. For example, I'm buying a spin bike for the house instead of going to the gym. This is as a primary example. So that's still trying to improve or catch up to where it was into a relatively good space. So that's a big issue in terms of the supply chain side of things. Now the one thing is the Bank of Canada has no control on supply chain. They can't really do anything. How they impact inflation or how they try to impact inflation is on local demand. And for them to do that, they raise interest rates.

So by rising interest rates it should in theory, slow demand. As cost of a borrowing increases cash flow gets tighter with increased expenses. In theory, it should slow local demand, which should also then help supply. Now obviously the supply chain problem is a global thing and there's a lot of factors around the world that I won't touch on too specifically, but that's definitely impacting us here locally just with energy prices and a lot of different metrics that make up most of the inflation numbers are being impacted globally. So the big issue is with the Bank of Canada is they're not really waiting for data because the problem is with raising interest rates, the actual data that will be able to be analyzed from the effect of raising interest rates takes a long time. So it's very lagging. We're not even close to a place where we can actually see the true impact of higher interest rates because the data is such a lagging indicator anyway.

So it takes time and that's when them being aggressive probably positions at where they become into that overshooting or they probably raise it too high is what a lot of people think because the economist that I heard present looked a lot at data from the 80s and 70s and when inflation was going up rapidly and then the central banks increased rates to combat. Both times, every time in history they've overshot, they've raised rates too high. So if you look at it from an actual restrictive zone would've been a Bank of Canada rate, probably even over 3%, but 3.5% or above for their overnight lending rate. With the increase today because they were at 3.25%, they went to 3.75%, they're well into that restrictive zone. So really if you look at it from a historical standpoint, they could probably ride it out and see what happens.

The problem is they're adamant on getting rid of inflation. That's their primary focus. So they're going to overdo it most likely to the point where they know for sure it's going to kill inflation and get it back down to their 2% target. So that's really the biggest driver of them raising interest rates is that's their biggest fear is inflation continuing. I mean the good news is for us in Canada is the Bank of Canada's actually probably a lot more influential and powerful when making changes to how it impacts the actual spending in the economy than the US Feds are because of how their system's set up. Bank of Canada is very influential. So if we see a 1% increase that might equate to a 2% increase down in the United States. So we'd probably see them go even higher. Now, not as many people are as impacted in the United States because they have long-term mortgages.

They might have terms that actually match amortization, things like that. So they might be protected around those different changes. However, there will obviously be people that will be impacted. But in Canada obviously with the average length of the term being five years and then the average length of a mortgage staying in the term less than four years, there's a lot of people that will have higher interest rates soon, whether if you're in a variable it's happening or if you're in a fixed it's happened or it's going to happen and it's just going to continue to happen as we move forward. So that's really the biggest difference. So that's good in terms of we might not see as much of an increase in terms of the Bank of Canada increasing their rates than the Feds will. That being said, based on what they mentioned, which was one of the biggest most important statements to take out of today's announcement is it reiterated that it's resolute commitment to restore price stability for Canadians so take action is required until they achieve its 2% inflation target.

So they're going to continue to go until they achieve their 2% inflation target. The question is, do they stop increasing to allow time to see the actual impact and benefit of the higher rates on inflation? Because clearly it's going to have an impact on spending and on demand. So where is that ceiling where they actually stop? A lot of people do think that it's probably at the next announcement, December 7th will be the last rate announcement of this year. Most economists and experts think that's probably the final increase for some time and then hopefully see a period of plateauing, stable interest rates from the Bank of Canada side of things. And at some point as we move through 2023, potentially early 2024, we might see actual rate cutting because we're going to be faced with some economic difficulties because of these increases. So there most likely will be a point where we see rate reductions.

Now does that happen sooner than later? I think the one factor that's important is if they keep that 2% as their target where they want inflation to be, then probably more into the 2024 range than 2023. If they increase their inflation target, because oftentimes they can increase their inflation target and then by doing that they can then cut rates sooner because they're more comfortable with that inflation number. So that's going to be I think a very important thing to look at is are they more comfortable or are they still continuing to focus on that 2% inflation target. Now in terms of mortgages, real estate, how this is impacting housing prices, all those different things. I think how the economist said it, Benjamin Tal, was an interesting thing. He said it's not a correction or a free fall, he called it a reallocation of activity. Now, that's a nice way of saying significant decline in activity.

Probably a lot of price changes or value changes in real estate also depending on the area type of property, I mean it's very specific to different areas because some areas especially in Greater Vancouver, where most of our clients are, aren't maybe seeing as much of a reduction as we're seeing other areas like maybe into the interior Kelowna, Kamloops, et cetera, right, are seeing even greater changes. Vancouver Island potentially more reductions there as well. So really area specific.

So a lot of actually market segments in greater Vancouver, we're actually still seeing multiple offers on specific properties if it's well priced in what was already a desirable property. Because it's not as though demands gone, it's just been delayed. If we look at it, A. Because cost of borrowings gone up so for sure and obviously sensitivity around what's going to happen, concern around what's going to happen. And then the other one is just the qualifying for the mortgage now has also become a little bit more difficult because that stress test rate still applies as rising interest rates happen.

So if the rate's at 5.5 or 5, whatever that rate is, qualifying at 2% over that is a lot different than qualifying a mortgage at 4.5% when rates were 2 or whatever that rate was, even though we used a higher rate at that time. So that's creating also difficulties from qualifying. So if the value of the home comes down or the value of the asset, well the mortgage cost has gone up and the qualifying is more challenging. So really it might have the same impact.

Now from an actual housing market long term, if you look at the data, one third of new construction has either been postponed or canceled. Now we already had a housing supply problem, whether it be rental, subsidized housing, affordable as they call it, or just market housing to sell for actual homeowners, home buyers we had a housing supply shortage. We had one for many, many years. They've talked about it when I was young, when I was first getting in the industry many years ago. We've been talking about it now. It hasn't been fixed.

One of the biggest issues around it obviously, if I pick on greater Vancouver, is the permitting process development application process is very delayed, very expensive, creates a lot of problems and then whenever governments generally look at it you'd think, well let's work around this. They're often focusing on, well the wealthy developers can just make less money per project and they can help us out in a way. That probably just doesn't happen. So what we're seeing a lot of developers do is we're actually seeing them build in other areas, whether it be Arizona, Texas, a lot of different countries, they're actually building projects because it's a lot more profitable, which also is a big concern.

Now if you add that to the fact that there's a shortage of trades construction workers actually people boots on the ground to build the properties also creates a big delay, but in turn increases construction costs, which also brings into the effect of their profit margins are shrinking. Hopefully we see some changes potentially with the municipal elections. We'll see some things speed up, but the problem is there's probably still not enough people to go out there. Even if it becomes more effective, cost effective and easier to build, it's still a lack of actual skilled workers to facilitate the build. So I think long term it's a problem. It's probably worse than most people think in terms of how much housing there is as we see rents. Even in the rental side of things, rents or skyrocketing. It's becoming very, very, very unaffordable rental purchasing no matter what. So it is something that needs to be tackled and hopefully it is at some point and there is a lot of policy that comes in to help that.

Now that being said, it's been years we've been thinking this and hoping this and hasn't happened. So if you own a home long term outlook is, well there's probably going to be a worse housing supply problem in the future. Demand's still there. When and if interest rates go down or they make it easier to qualify for the mortgage again or they do something around extending amortizations for mortgages because there's a lot of different tools they have to make payments lower but have a higher rate environment. Like we used to see 40 year amortizations not that long ago. If you think about it, maybe it was 12, 15 years ago, we used to see longer amortizations even for high ratio insured mortgages were up to 40 years.

So that made payments a lot lower in a higher rate environment. That could be something, nothing set in stone. There's just a lot of obviously lobbying for different things to help homeowners especially at renewal time because renewals become I think a very lot more stressful situation. Where it used to be not because there wasn't as much of a rate increase in that period of time. So the question of renewal is with a higher interest rate, even if you're a fixed rate client going from 2-3% up to 5-6%, as we see rates change over time, that payment shock is significant. So what are some ways around or to protect against that? I mean a few would be extending amortization again would lower the payment down. The other one is potentially doing a shorter term rate, like a short term fix in this market to sort of see how things go over the next little while.

I'm very cautious around anyone asking about locking in, especially at a longer term because depending on how much time you have left in the variable rate mortgage, you generally have to lock in at the length of time remaining or longer interest rate. So let's say there's three years left. I mean some lenders just use the five year, but if there's three years left, potentially you could do a three year, four year, or five year rate, which those are actually inverted a little bit because of the bond yield inverted, which is causing a lot of problems as well for banks pricing fixed rate mortgages. So with this increase we probably see another little jump in interest rates. TD Bank actually messaged us this morning to look for a rate increase sometime this week with more details to follow. Because when this happens, they're going to just go, oh we need to be careful. We need to price rates so our profit, our margins are still at a point where we're not going to be in trouble.

The problem is with the banks right now is the volatility of the yields, the inversion of the yields, a lot of different factors is very difficult for them to price interest rates to be comfortable with them. Even if you look at what the actual yields are to where rates are, they're probably priced too high in theory versus historical trends. But I would say primarily because of the instability around rising interest rates, the stock market, et cetera. When we hopefully get to that point, let's say December and that's it, we don't see any more rate increases and we move into the new year, and there's a little bit more stability often I think that we could potentially see fixed rates lower before we see the Bank of Canada lower. So that might be something to keep an eye out depending how long you have left in term. If there's two years left and two year rates are now lower again, maybe it does make sense to lock in for that remainder of the two years knowing that we're not going to be moving out of the mortgage or hang out the mortgage.

Because that's always the number one thing is what's the plan? How long will we be there for? What's the exit strategy? How do we protect against big costs when getting out of the mortgage? Those are really important things to look at. So locking in today when we're probably near that high end of the rate market, hopefully is I think difficult to see being a good idea given the high probability of lower rates at some time in the future. Because even in locking in the rate goes up, payments go up right away. And the other question that we received a lot is what is a trigger rate? So trigger rate, which not all banks have because everyone handles variable rate mortgages differently. So many lenders will actually adjust the payment as prime rate changes. So as the rate goes up or down, the payment will also go up or down. Amortization stays the same.

Some banks like a TD Bank, Royal Bank, what they actually do is they adjust not the payment, the payment stays the same, they adjust the interest portion of the payment. So amortization will lengthen or decrease based on what the rates are doing and what the rate was when the mortgage was originally structured. So that's bringing up this term trigger rate, which has obviously not been talked about much if ever in the last 20 years for sure. So trigger rate is when you get to the point where the rate now is the point where you're paying all interest. So there's no principle repayment of the mortgage, it's only interest. So that's where a good conversation is. Well does it make sense to increase the payments? Are we mostly worried about cash flow? Because most of the banks will not force you to increase the payment in most scenarios unless you're at a point where you're over the trigger rate and now your payment doesn't cover the interest.

So you're actually adding on to your mortgage because the interest will be added onto your balance and that balance gets you 80% of the home value or more. Then they might say, okay, we need to do something with your payment. Until that point, generally they won't. So their payment is still some protection there, but just keep in mind that at renewal there might be a higher balance if that's happening. So really it's an important thing to look in, know what the trigger rate is, know what your discount off of prime is, so then you can figure, okay, here's my rate, here's what the trigger rate is and know what that looks like and plan around that, and protect yourself against those situations. And then fixed rate clients obviously seem protected, but it's definitely something to be planning for because they're not protected, right?

Because if renewal is in six months, a year, whatever that time is, that rate's going to be probably a significant difference from where it was. And if amortization stays on the same payment, same frequency, large payment increases. So these are definitely things to really focus on. Now oftentimes the one thing is we can't necessarily figure out a way to lower the payment unless we extend amortization, things like that. There's equity to do it. What we can focus on is really getting detailed and specific around home budgeting and how do we really protect ourselves and implement a budget that is affordable in this high cost market. What do we cut out on a monthly basis? How do we can really get lean in these maybe more difficult months ahead? And that's something that we're talking to a lot of clients around is getting back to basics and back to that home budget and really looking at how do we maximize cash flow?

Because if we think about it, it's very simple. Income minus expenses, we want that net result, that cash flow, how much do we have left over every month to be as high as possible to then be able to use it as best as possible to benefit you. So we'll be hosting another webinar livestream sometime end of November, early December with a certified cash flow specialist I know, financial planner. And we'll be sending out information on that because I think it's something that we could all do better on. I know me personally, business is shifting, expenses are still there, right? I'm in a variable, I see what's happening. So we're all in the same boat. So it's just supporting and having knowledge and tools to protect ourselves and position ourselves to be best situated until we get to that point where we see a little bit of an easing, which hopefully comes sooner than later, but it is looking and sounding just by what the Bank of Canada said.

Which also they say a lot of things because it wasn't that long ago that Tim Macklem said that rates are going to be low and they're going to be low for a long time. Didn't happen. So it's ever changing, I think as data comes. No one knows the future, but it does look like they're pretty adamant on the inflation side of things and they really want to dampen it and squash it and get rid of it. And to do that they want to rise interest rates. Hopefully they set and they stop and just let's see what happens. Because again, we're going to need many months of actual real life spending and data to know what has happened and what does the rising interest rate actually do. So those are the things to look at. So if you own the property, the good news is value's probably going to be higher in the future because there's going to be less homes and they're building less, which means we're going to have a supply shortage.

Population growth is still happening. Over 500,000 new people coming to the country in the next six months. And these are skilled people, these are new immigrants that are already students in Canada that are come out university educated. So there's more purchasing power from the people coming. So that's also going to impact, I would say the purchase market. So these are all good news, good things for us that own homes. Long term, values probably healthy and ongoing and upward. The other thing is just to know that we'll have to just watch and see what happens with home building because it's definitely, definitely slowing from new home builds. Is there innovation in the industry? Will they find ways to make housing more efficient, more affordable to build? Because it's not just most of our clients that own homes, it's also the people that don't own homes that are being heavily impacted by this with rising rents.

And it's how do we help this problem moving forward? So hopefully we see some positive impactful changes over the coming months and years and see that move in the right direction. But for now, I would say patience. Patience is a very helpful thing. I know when rates are going up, we're in a variable, it often looks like, well, I should probably lock in just to protect myself. Questions to ask are, how long will I need this mortgage for, be in this house for? Because anyone that locks in or has it, because the banks are being very aggressive. By far their goal right now is they want everyone to lock into a fixed rate mortgage, make more money, less management, and they're protected against when that mortgage is paid out. And the penalty will be significant, especially if it's a big bank. For example, Scotia Bank, you're going to lock in at the four or five year rate, posted rates well over 6%.

So when you pay out that mortgage, we're using that posted rate and the discount you received off posted and comparing it to what the posted rate is in the future, which is a high probability of being a lot lower, and then using that same discount, which creates that interest rate differential and a very, very big penalty over the coming years for anyone in a fixed rate mortgage.

So thanks for being here. I hope this was helpful and always here to help, always here to be of service, and grateful for you and we'll talk to you soon.

Introduction: Thanks for listening to the House Rich Podcast with Matt Parker. We hope you enjoyed this episode. For more information and resources to get you started on your home ownership journey, visit www.mattparker.ca and don't forget to rate and review this podcast. Thanks again for listening.