Have you locked in your fixed-rate mortgage?

Mortgage borrowers should prepare for more sticker shock this month. Rate hikes are on the way. Bond yields are rocketing as a result of soaring oil prices, which in turn are fueling bond yields.

According to some market pundits, crude oil may break its record, which topped US$147 a barrel in 2008. This would probably be the worst outcome for inflation, short of perhaps a nuclear war or a giant asteroid colliding with Earth.

Investors are partly selling bonds due to this inflationary threat, which is causing the yield on five-year bonds to increase. Fixed mortgage rates are heavily influenced by yields.

Average uninsured five-year fixed rates have increased by 300 basis points since September. At that time, you could get a five-year fixed rate for just 1.99 percent. 100 basis points is one percentage point.

Now what?

Oil prices threaten to send yields and fixed rates spiraling out of control. We seem to be caught in a “1994 moment.” And there’s no way out in the near future.

If you don’t remember five-year fixed rates in 1994, they shot up 350 basis points in five months as central banks hiked policy rates to ward off inflation.

All we’ll see is a 1994 replay if we’re lucky. A replay of 1981 – a runup of 1,000 bps in 10 months – would be less pleasant. Despite the fact that we have little chance of seeing even half of that.

The interest-rate sensitivity of Canada’s economy can be traced back to 1990, according to CIBC economist Benjamin Tal. According to Mr. Tal, comparing 1990 with today, “we are 93 percent more sensitive” to rate increases.

Therefore, the Bank of Canada doesn’t need to raise rates as much to slow domestic demand. This is the main reason why rate hikes of 300- to 450-bps are more likely this time around. At the moment, the bond market is pricing in about 350 basis points.

However, foreign supply chain disruptions are a wild card. They are another major inflation catalyst beyond the control of the Bank of Canada, and they could partially offset the rate sensitivity factor.

Is it too late to lock in?

The question is, at what rate will you lock in? Around 5% for five years?

Not unless you’re a poster child for risk avoidance. Five years is a long time to be stuck at a rate that’s 80 percent above the 10-year average.

As growth slows, the prime rate will return to its mean. This is a mathematical certainty. The only key questions are: When, and how much higher, will that mean average go?

Given how things are unfolding, the Bank of Canada may have no choice but to break housing’s back by raising its key rate at least 13 times higher than it was on March 1. In other words, to 3.25 per cent or more.

To stop this inflationary spiral, the bank must shock and awe.

Due to our central bank’s lateness, and this year’s massive blow to its credibility, bond traders and consumers must be pressed into believing inflation won’t last too long.

On June 22, inflation could reach 7.5 percent. That would certainly frighten people.

Inflation expectations and five-year fixed rates may only peak this year with rate hikes of 75 to 100 basis points. Nevertheless, the central bank must act quickly – before inflation beliefs spiral out of control.

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Real estate sentiment collapse

Canada’s housing market has been geared toward 1.99-percent rates. It now faces 5-percent rates and astonishingly high mortgage qualification rates. The government’s stress test will soon require applicants for five-year fixed mortgages to prove they can afford rates of more than 7 percent. Five-year qualifying rates were last that high in the early 2000s.

Normalizing rates was expected to pressure home prices, but those expectations were based on rates doubling. That’ll be a triple if we get into 5-percent territory on fixed rates. As a result, the implied value of housing – based on debt-to-income ratios (that is, what borrowers can afford) – will further erode.

Because of immigration inflows and record-low unemployment, mainstream economists do not predict a real estate panic. The home-price prediction business isn’t my forte, but maybe we’ll see a quick V-shaped bottom as we have in the past. Know this. With record-high leverage, all bets are off if stress test rates end up in the high 7 percent or 8 percent range.

This week’s mortgage rates…

With yields surging, average five-year fixed rates could be 15 to 25 basis points higher within seven to 10 days. By the end of next week, most banks could be at or above 4.74 percent on discounted five-year fixed rates.

Always check regional rates from brokers and credit unions to find the best deal. Community Savings, for instance, offers a killer 3.89-percent (uninsured) five-year fixed rate in British Columbia.

Lowest nationally available mortgage rates

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These are the current rates from providers that advertise rates online and lend in at least nine provinces as of Wednesday. Insured rates apply to those buying with less than a 20-per-cent down payment, or those switching a pre-existing insured mortgage to a new lender. Refinances and purchases over $1-million are subject to uninsured rates, which may include applicable lender rates. For providers with varying rates by province, the highest rate is displayed.

Source: https://www.theglobeandmail.com/investing/personal-finance/household-finances/article-mortgage-shoppers-beware-surging-oil-is-pushing-five-year-rates-above/

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