The age-old rate debate. In this blog post, we talk a bit more about whether variable rate mortgages are better than fixed.
Will the novel coronavirus impact mortgage rates?
When out racing in a sailboat, sailors create a game plan before the start of the race. Before the start of racing for the day they analyze weather reports and the geographical layout of the racecourse. When they get to the course, they analyze the conditions that they see when they are out there. Oftentimes they see a “favored” side to the racecourse or one that will pay off better than the other.
When the race starts, the sailors will sail on the side of the course that they feel is favored. While one side of the course could be incredibly favored, sailors can be hesitant to put all their eggs into one basket. The wind can still shift back and forth causing that one favored side to no longer is favored. Sailors will take a conservative approach to play the shifts on that side of the course and watch what the rest of the boats are doing. Living in unprecedented times, lenders are taking a conservative approach to the mortgage industry. Here we talk a bit more about how COVID-19 will impact mortgage rates.
Changes to the overnight rate
Back in March, we saw the Bank of Canada update the overnight interest rate. The policy interest rate, or overnight rate, is the interest rate that financial institutions borrow and trade at. Changes in the overnight lending rate understandably have an influence on mortgage rates and loans for consumers. When the Bank of Canada wants to stimulate the economy, it will lower the overnight rate. Consumers will then feel more inclined to buy products and make transactions since rates are low. When the Bank of Canada wants to cool off the economy, it will raise the overnight rate.
At the beginning of March, we saw the Bank of Canada lower the rate by half a percentage point to 1.25%. The following couple of weeks the Bank of Canada lowered the rate another two half percentage points to a final overnight rate of 0.25%. The Bank of Canada lowered the overnight rate in hopes of improving the function of the market and increasing liquidity so that consumers have access to the credit they need. Changes to this overnight rate will have an impact on the bank prime rate offered to borrowers.
Changes to the prime rate
Following changes in the overnight rate, we typically see lenders update their prime rate in a corresponding response. When the Bank of Canada lowers the overnight rate, lenders will usually lower their prime rate. When the overnight rate rises, lenders raise their prime rates.
You can think of this prime rate as a baseline value. Borrowers that are in variable rate products will see interest rates change in response to these shifts. For the existing variable-rate borrowers, you will see a reduction in the interest portion of your mortgage. The mortgage rate you see on a lenders website is called the posted rate. This is represented as a percentage value but the calculation often depends on the prime rate.
For variable-rate products, the rate is often calculated as prime plus, or prime minus. Based on your financial fitness the lender will offer you a rate relative to the prime rate. Lenders will sometimes incentivize fixed-rate products when there is volatility (uncertainty) in the marketplace. Fixed-rate products are influenced by the prime rate, but the actual rate does not change over the term of your loan.
How does this impact mortgage rates?
For new home buyers, we are seeing lower posted interest rates in response to the lower prime. However, this can be a bit deceiving. Previously, many lenders were offering upwards of 100 basis points (bps) below prime. This means that as prime increases or decreases, so does your rate. Even though the posted rates are low right now, this discount on prime may be less than in previous years. This means that when the prime rates increase in the future, the discount on prime may be less than it could be. With this in mind, the rates are at close to all-time lows as the market starts to stabilize. Rates change daily, so it’s important to get a pre-approval in place when considering purchasing a new home. An unbiased mortgage professional will help you understand what a good rate looks like, and help you plan for the future.
When out on the racecourse, there is a constant risk that conditions could change in the blink of an eye. To avoid the risk of losing to competitors around them, sailors take a conservative approach to their tactics. They will hedge towards one side, while still watching boats around them. Lenders are similarly taking a conservative approach to the market during COVID-19. In an effort to protect themselves. For borrowers that are shopping for a mortgage, now is the time to lock in a rate. When looking to lock in a rate and build your financial future, give us a call at Clinton Wilkins Mortgage Team! You can give us a call at 902-482-2770 or get in touch with us here!