Is Era of Historically Low Mortgage Rates Coming to an End?

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Over the last week of September, the bond market jumped sharply, and the five-year bond yield has now climbed above 1% (back in the spring, it stood at just 0.4%). Does this mean historically low fixed rates will soon be a thing of the past?

The yield on Canada's five-year government bond represents the return an investor earns for holding five-year Canadian government debt until it matures. Since these government bonds are backed by the Canadian government, five-year Canadian bonds are considered the safest available five-year investment. Thanks to their lack of risk and high liquidity, they're commonly used as the benchmark for interest rates on a range of financial products in Canada.

Fixed mortgage rates are based on the yield of Government of Canada bonds. That's exactly why the most popular mortgage term in Canada, the five-year fixed, is tied to the five-year bond yield. While it can drift from its usual path for short stretches, the gap between five-year bond yields and five-year fixed rates always returns to its long-term average.

Fixed mortgage rates began climbing in late September. Experts had anticipated this, pointing to the sharp rise in government bond yields. The best five-year fixed mortgage rate has ticked upward several times recently, but as of October 1, there were still a handful of lenders where we could get our clients a special offer at 1.99%. Five-year rates appear likely to settle around 2.2% for a while, unless bond yields suddenly change direction.

We're still going to see bond yields and five-year fixed rates rise and fall as Canada's uneven economic recovery continues to unfold. That said, this recent increase may signal that the extremely low fixed rates of this economic cycle will soon be behind us.

The cost of borrowing is critically important to the financial health of Canadian households. Overall, Canadian household finances are in good shape, according to TD economist Ksenia Bishop, though they still depend heavily on low interest rates and rising home values.

BMO economist Shelly Kaushik is genuinely concerned about Canadians' overall financial position. She notes that the household debt-to-disposable-income ratio rose 5.4% in the second quarter (unadjusted for seasonal factors), reaching 172.9%. That's the largest increase since at least 1990, when this ratio was first tracked, following six consecutive quarters of decline. Bishop pointed to a 2.5% quarterly jump in total debt (this time seasonally adjusted), nearly double the pace of the previous two quarters. Unsurprisingly, mortgage debt played a major role here, rising 3.4% for the quarter and a full 10% year-over-year. Both figures are also records.

The good news comes from the other side of the financial ledger: asset values. Household net worth rose 3.7% compared to the previous quarter and 19% compared to a year earlier. Importantly, the debt-service ratio (the cost of monthly debt payments relative to income) fell from 13.5% in the first quarter to 13.3% in the second. Even though total household debt rose nearly 7% compared to last year, interest payments actually fell 4.3%, Bishop notes.

In other words, Canadians really have taken on a lot of debt, but they can currently afford it under today's conditions. The unrelenting rise in real estate activity, combined with strong stock markets boosting the value of pensions and RRSP savings, has driven a sharp jump in net worth, which is currently helping offset the debt burden. But that, of course, could all change if borrowing costs rise significantly or asset values fall, especially if both happen at the same time. Monthly mortgage payments would strain household budgets, and overall net worth would take a hit, since the debt would remain in place even as asset values declined.

It's fairly easy to view household finances as fragile and precarious given rising debt levels, but any changes to rates will most likely be gradual (Bank of Canada Governor Tiff Macklem is certainly well aware of the data above). What's more, since the cost of servicing debt has fallen significantly over the past year, Canadians have some breathing room before rate increases start delivering a serious financial blow to the average borrower.

Please keep your finances under control, build yourself an emergency fund covering 3-6 months of expenses, and always think carefully before making decisions involving credit, interest rates won't stay this low forever.

Rapidly rising home prices aren't dampening Canadian homeowners' optimism just yet. According to the Canadian Real Estate Association (CREA), national home prices posted their first monthly increase since February, as market supply fell to an extremely low level. The average price in August came to $663,500, up 13.3% from a year earlier and up 0.5% from July, bringing a four-month streak of declines to an end.

The average price is down 7.4% from its March peak. Excluding the pricier Greater Toronto and Vancouver markets, the average price comes to $533,500. 50,876 transactions were completed in August, down 14% from a year earlier, though this still marks the second most active August on record, CREA reports. Canadian real estate markets are stabilizing somewhere between pre-pandemic levels and their peak, and these are genuinely volatile figures, says CREA senior economist Shaun Cathcart.

Supply, already at historic lows, fell in August to a level where it would take just 2.2 months to sell everything currently listed on the market. For analyst Ben Rabidoux, president of North Cove Advisors, this sharp drop in supply is the defining story of the Canadian real estate market right now. Our unsold inventory has fallen 60% since 2015, he said during a recent webinar hosted by Mortgage Professionals Canada. It's a genuinely absurd, punishing decline, and it's the story facing Canadian real estate right now. According to Rabidoux, for prices to actually start falling, supply would need to more than double and/or sales would need to fall by half. We're so far from a balanced real estate market that we could double supply and the market would still favour sellers, he says. We have a chronic supply shortage.

Here are the results from regional and local real estate markets for August 2021:

Ontario: $834,932 (+15.1%)
Quebec: $451,904 (+14.7%)
British Columbia: $899,173 (+16.8%)
Alberta: $417,321 (+4.2%)
Barrie and region: $739,200 (+35%)
Greater Montreal: $497,800 (+21.7%)
Victoria: $854,300 (+19.8%)
Halifax-Dartmouth: $442,284 (+19%)
Ottawa: $653,200 (+18.5%)
Greater Toronto: $1,059,200 (+17.4%)
Greater Vancouver: $1,176,600 (+13.2%)
Winnipeg: $318,900 (+11.6%)
Calgary: $446,500 (+10%)
St. John's: $286,200 (+7.6%)
Edmonton: $343,100 (+5.8%)

Given tight supply and rising home prices, CREA has released an updated forecast for the year. The association now expects 656,300 transactions in 2021, up nearly 19% from 2020, though slightly below the previously expected 682,900 transactions.

Sales are expected to decline 12.1% next year, down to 577,000 units. Limited supply and higher prices will slow activity next year compared to 2021, but increased flow into the resale market, driven by pandemic-related lifestyle changes for many people, will continue to keep activity above normal, CREA notes.

The association has also raised its forecasts for average home prices. It now expects average prices to rise 19.9% year-over-year in 2021, reaching $680,000, up from its previous forecast of $678,000. Next year, prices are expected to keep climbing, reaching $718,000 (a 5.6% year-over-year increase).