Updated: Oct 4
What the heck is happening with mortgage rates, real estate prices, and the bond market? How are they connected, and what does all this mean? There is so much noise going on and speculation on what interest rates are going to do and what the effect of that will be on housing prices that it is easy to just sell everything you have and run for the hills. But for real, it can get super confusing. So what is all this about? What is going to happen with the housing market? Above is the 10-year bond yield from 1970 to the current, with crisis points marked out. Are we going to continue to follow the trend? My guess is yes.
Let’s make this as simple as possible. When you go to the bank for a mortgage, they will offer you a choice of going with a fixed-rate or a variable-rate mortgage. Fixed-rate mortgages are largely determined by the bond market. To understand the details on this, we first must understand how bonds work. Bonds are typically issued by governments and large corporations, but they can also be bought and sold on the secondary market like stocks. The easy math in a low-interest-rate environment looks like this: The Bank of Canada sells you a bond for $1,000 with a 2% fixed interest rate for 5 years. However, two years later inflation worries start to heat up due to a global pandemic and unprecedented government spending. Sound familiar, anyone? Now with inflation at 5 and 6%, your 2% return on the bond doesn’t look so good, so you decide to sell it on the secondary market. The problem is, new bonds are now being issued at 3%, and no one wants to pay you $1,000 for your 2% bond, so you may be stuck selling it for a discount. This allows the buyer to get a better return, and since mortgage rates are tied to bond rates, fixed-rate mortgages start to jump up.
Variable rate mortgages are a little easier to understand. They are based on the overnight lending rate. This is the rate typically set by the central bank (Bank of Canada), and each individual bank (TD, Scotia, RBC, etc.) sets their prime rate based on this number. The variable rate that they give you will be a discount or premium on the bank’s prime lending rate.
When interest rates rise, the cost of borrowing money goes up. So, logically, a typical home buyer will be able to afford less house and a smaller purchase price than when the rates were lower. This can price certain people out of the market and takes a bite out of cash flow for the investor. Fixed-rate mortgages have been on a tear lately, and the Bank of Canada threatens to raise their rates almost on a weekly basis. This will probably take the steam out of a hot real estate market in Canada. That’s not a bad thing. It isn’t sustainable for a market to be on a tear like it has been over the last few years.
High demand and low inventory have been the story over the last little while. That is still true and fundamentally continues to underpin the market. As the year goes on and higher rates take effect, there is a chance that demand will peter out a little, and inventory will pick up to match. This could result in a slowdown in the back half of the year.
How high can the variable rate go? We aren’t sure. We can say that with the historic debt levels in all levels of government and at the consumer level, it can’t go too high without risking a recession. Or alternatively, as the chart above points out, no matter how high-interest rates go, when you adjust them for inflation, they are likely to be negative for the foreseeable future. When recessions hit, our friends upstairs start printing money and sending it to the consumer and begin to pull the interest rates back to kickstart the economy. This leads to inflation, and the cycle starts all over again. Who wins through all this? People that hold hard assets like cash-flowing real estate and gold.
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Real Estate Investor and Entrepreneur
Jonathan Beam is a real estate investor in the Niagara region who is passionate about helping you achieve financial freedom through real estate. He works with new and experienced investors to formulate a plan that fits your specific situation and provides market guidance and consultation on the best places and strategies to pursue within the Niagara Region. Book a free, half hour no obligation consultation to see how he can help you to achieve your goals. His travels are available at www.realestateandrepeat.com
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