Friday, August 03, 2012

Why do interest rates continue to fall?

What can we make of the low interest rate environment we are now seeing? Fixed rates are dropping and one lender has dropped its variable rate. Will more lenders follow suit?

When the five-year fixed rate fell to under 3% earlier this year, Finance Minister Jim Flaherty and Bank of Canada Governor Mark Carney cautioned consumers and warned lenders to be careful with debt loads. Clearly it didn’t slow the robust housing market – purchases and refinances continued at a pace not seen since 2007.

Then Flaherty announced some changes to the mortgage rules to slow down the pace of rising debts. So what happened? We had a couple of weeks of quiet as the summer was also upon us.

It appears both lenders and investors are not comfortable with a lull. They have been taking advantage of lower bond yields, which accounts for lowered fixed rates. Even the seven and 10-year rates are looking very good. At the time of this writing a seven-year rate can be had for 3.69%. The spread between the posted rate on a five-year mortgage of 5.24% and a government of Canada five-year bond is almost 400 basis points — the highest it’s been since the financial crisis in 2008.

Also, a few monoline lenders – lenders who specialize in mortgage lending only -- are now offering their variable rate under prime --something we have not seen consistently since last Fall. Clearly, these lenders have an appetite for funding right now. It will be interesting to see if this initiates a mini-price war in the variable rate market. But there is always the threat that the government will step in and introduce even tougher rules.

These rates continue to tempt consumers. This may be the best time to consolidate even if it’s only to 80% of the value of your property.  On the other hand, the challenge is the increasing debt loads that a low interest rate environment can create.

Craig Alexander, chief economist at Toronto-Dominion Bank suggested in a recent news article that consumers should not abuse this opportunity by taking on new debt but should take advantage of it.

The Canadian Real Estate Association had previously forecast housing sales in 2012 and 2013 that were roughly on par with the 10-year average for annual activity. The updated forecast now predicts activity slightly above the long term average. The national average price is also forecast to rise modestly in 2013, edging up two per cent to $378,200.

It’s hard to heed the warnings from government when the economy, the job market and the housing market seem to be doing so well.

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