Today’s Value Zone: 3-year Rates

Mortgage Report – May 11

• Hitting Triples: Borrowers would love to see 5-year fixed rates under 2% and eventually they’ll get there. But for now, banks are “reducing mortgage rate discounts to conserve profitability,” as Deloitte put it in a recent report. Alas, we’ll have to make do with the historically low rates we already have. And for all you fixed-rate fans, the lowest fixed rate in Canada is now the triple-year (3-year) fixed at 2.09% or less. (Forgive the baseball reference. We miss MLB.) As is so often the case with the lowest rates, however, restrictions apply. This deal is available only to default-insured homebuyers or those with 35%+ down. If that matches your financing needs and you’re well-qualified and risk-tolerant, it’s worth a look. A 3-year fixed is more flexible than a longer term because it lets you refinance sooner (or discharge your mortgage sooner) with no prepayment penalty. The typical mortgagor renegotiates or discharges in roughly 3.7 years. And, for market bears who don’t think Canada will see above-target inflation in the next 33 months, a 3-year at 2.09% gives you Canada’s lowest fixed rate with no upside rate risk until mid-2023. At that time you can renew into any term you want, including a deep-discount variable, if they’re available by then (they should be). By the way, we say “33 months” because you can usually lock in great rates on your next term 90 days before your maturity date.
• Five Years for 2.14%: HSBC’s default insured 5-year fixed at 2.14% remains RateSpy’s most-inquired-about rate for the second straight week. At just 5-6 bps more than the lowest fixed rate (noted above), it’s attracting a flood of interest. Several competing lenders could match this rate as profit margins support it. But, curiously, they’re not. Competitors apparently don’t believe they’ll lose enough business to HSBC’s leading discounts. Or perhaps they think people will pay extra to avoid HSBC’s potentially high big-bank-style prepayment charge.
• Banks Still Paying More: Big 6 Banks are still paying 35+ basis points more than normal to fund 5-year debt. That premium raises their “weighted average cost of funds,” which often leads banks to charge more for mortgages. Were funding costs more “normal” right now, we’d already be seeing 5-year fixed rates under 2%. To break that 2% floor, it’s likely that either:
  • base funding costs (as measured by bond yields or swap rates) must drop, or
  • the risk/liquidity premiums banks are forced to pay must drop. One or both could very well happen by the end of this year.

• Forward Thinking: The market thinks 5-year rates will be higher in five years, about 40 bps higher based on 5-year forward contracts. These forward contracts essentially let traders bet on where rates will be in the future — in this case, in 2025. A few months ago, the market was pricing in no change in 5-year rates through 2025. BoC rate cuts and government relief measures changed that thinking mighty quick. Forwards are volatile instruments and not the most reliable mortgage selection tools, but they do provide an instructive reminder that rates can go up following economic downturns.
• COVID Disloyalty: In a report this month, Deloitte says the coronavirus crisis is “likely” to encourage more switching of lenders “than ever before” as borrowers “face challenges getting banks to respond to their needs quickly and effectively.” Hence, not only will COVID cost unresponsive lenders mortgage originations today, but it’ll cost them renewals in the future.
• Deferral Modelling: Another nugget in Deloitte’s report was that banks are analyzing which borrowers have requested mortgage deferrals. Banks’ purpose is understand commonalities in these customers and “capture the risk that is not inherent in [traditional] credit scoring models,” Deloitte explains. Banks will apply that knowledge in future underwriting decisions to manage their risk and adjust mortgage pricing. That means customers with a higher probability of requesting a mortgage deferral (those in higher-risk industries) might pay slightly higher mortgage rates.
• CERB Kills Mortgage Approvals: Shady mortgage applicants underestimate lender due diligence. We heard from a broker this weekend about a mortgage applicant who told his lender he was working. The lender then noticed a $2,000 CERB deposit in the client’s bank account. It told the broker it was cancelling the mortgage approval since the client was either committing tax fraud or lying about their employment status. Mortgage applicants who get laid off, have their hours cut back or apply for government assistance before their mortgage closes should expect disappointment if they try to pull the wool over lenders’ eyes.