The apocalypse for overextended borrowers was cancelled on Wednesday.
Thank the U.S. Federal Reserve, which cut its trendsetting interest rate by one-quarter of a percentage point. In a stroke, the Fed killed the expectation that interest rates would rise back to historically normal levels and crush people with big debts.
This may still happen in the long run. But for now, the global economy is stuck in a slow-growth rut and may even be losing momentum. There’s no justification for higher rates, other than the hunger of conservative investors and savers for better returns.
The Fed move affects Canadians in a bunch of important ways. Lower rates are good for stocks, which have already been on a tear in 2019. U.S.-bound travellers, you may find that the exchange rate you get when converting Canadian dollars into U.S. currency improves some. Our dollar could benefit if rates are stable here and falling in the United States.
But it’s borrowers who will be affected most by the Fed’s rate cut, though in an indirect way because the Bank of Canada is expected to hold rates steady here. This view was reinforced by a report on the economy for May that showed a reasonable level of growth.
As the Bank of Canada’s overnight rate goes, so go the costs of borrowing via home equity lines of credit, floating rate loans and variable-rate mortgages. Rates on these borrowing vehicles are locked in as long as the Canadian economy holds up.
Rates on fixed-rate mortgages have fallen this year and the trend looking ahead is favourable if you’re renewing a mortgage or buying a house. The cost of fixed-rate mortgages follows what’s happening in the bond market, where interest rates have fallen hard in the past 12 months.
The Fed’s rate cut validates the view in the bond market that economic growth is slowing, that inflation is no threat and that interest rates need to be lower. Lenders seem to disagree on just how low mortgage rates should be, however.
Discounted five-year fixed-rate mortgages at national mortgage brokerage firms were available on Wednesday at 2.69 per cent, while major banks were showing special offers of 2.97 per cent to 3.39 per cent. You may have to consult a mortgage broker to squeeze the most benefit out of falling borrowing costs.
Today’s rate environment is a weird one because, in an inversion of the normal way of things, short-term borrowing costs are actually higher than long-term costs. One of the mortgage brokerage firms offering the 2.69-per-cent five-year fixed-rate mortgage showed a rate of 3.04 per cent for one year, 2.89 per cent for two years, 2.79 per cent for three years and 2.94 per cent for four years.
Five-year fixed-rate mortgages are the best all-around value today – you get five years of not having to worry about your mortgage rate and an exceptionally low rate, period. Even variable-rate mortgages can’t compete. Usually available at lower rates than fixed-rate mortgages, a discounted five-year variable rate mortgage today is going at rates of 2.9 to 3.3 per cent.
What’s good for borrowers is generally bad news for savers and conservative investors. Returns on high-rate savings accounts are holding firm for the most part because they’re linked to what the Bank of Canada is doing. But guaranteed investment certificates mirror what mortgages are doing, which means returns are shrinking. If you have GICs to buy or renew, don’t delay.
The interest rate outlook today is a 180-degree shift from a year ago, when the Bank of Canada was still raising rates. The country absorbed those rate increases fairly well, although the national savings rate has fallen to almost nothing.
Now, borrowers get a reprieve from even higher borrowing costs. It’s a gift – don’t waste it by getting complacent about your debt load or, worse, by borrowing more. The more debt you pay off this year and next, the better prepared you’ll be for whatever happens in the economy.
Remember, rates are being lowered to address concerns about the economy. Lightening your debt load and building your savings are the best defence.
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Rob Carrick