on August 16, 2023 
Statistics Canada released it’s July inflation report yesterday, and the CPI headline inflation rate rose from 2.8% in June to 3.3% for July. To put it bluntly, that’s not good news for mortgage rates.
However, a closer look at the data shows that mortgage interest, energy and grocery prices are the 3 culprits in pushing headline inflation up. If you strip out those 3 components, the CPI is running at just 2.3% year over year. Mortgage interest costs the single biggest factor in the increase, up a whopping 31% – a direct result of the Bank of Canada’s (BoC) interest rate hikes – meaning in a twisted way the BoC’s actions to fight inflation are currently the leading cause of it.
Gas prices are also troublesome, but moreso because of their natural volatility due to external factors. Prices at the pump only rose slightly by 0.9% in July compared to a month earlier, but last year (July 2022) they fell by 9% so in comparing the prices year-over-year it looks like a large increase.
Last but not least, the prices of groceries are still increasing much faster than we’d like, but the good news here is that the rate of increase is slowing. In June grocery prices increased by 9.1%, while in July they increased by a lower 8.5%.
The overall story here is that we’re now through the easy victories in the fight against inflation, and the remaining ground to cover is going to be more challenging and take longer.
What does this mean for mortgage rates and real estate?
Given the persistentence of inflation in Canada and the relatively robust employment data in Canada and the U.S., it currently looks likely that the BoC is going to have to keep it’s policy rate high for at least another 12 months. There’s even a decent chance that we’ll see another quarter point Prime rate increase over the fall or winter if the CPI headline inflation rate proves stubborn and plateaus rather than continuing in a slow decline.
Looking ahead further though, it seems very likely that interest rates will begin dropping in late 2024 and through 2025.
Why? Well, as mentioned above, one of the biggest drivers of inflation right now is the cost of mortgage interest and this is only just beginning to impact our economy as a whole. People who have adjustable rate mortgages (the ones where the payments increase every time the prime rate changes) have been experiencing the increasing mortgage interest costs in real time, but these mortgages are only a small percent of the overall canadian mortgage market. Most Canadian mortgages are fixed rate term contracts, and so the mortgage interest cost for these borrowers doesn’t change until their mortgage comes up for renewal at the end of their term and they have to start a new term at today’s interest rates. The most popular fixed term is 5 years, so this year the borrowers who started a 5 year term in 2018, when rates were between 3-4%, have been faced with renewing at rates in the 5-6% range. In 2024, it will be the borrowers who started their 5 year term in 2019, when rates were between 2-3%, who are forced to renew at much higher rates – likely double or more. 2025 will see renewals for borrowers who got a 5 year term in 2020, when rates were in the 1.5-2.5% range, who will be renewing into fixed rates that are going to be double-to-triple their previous term. And so on…
This is the slow but inevitable “renewal crisis” facing Canadian mortgage borrowers, and as it unfolds it will suck a very significant amount of discretionary spending out of our economy. Each time a fixed rate borrower renews over the next 3 years, that household is going to have to reallocate hundreds of dollars more towards their monthly mortgage payment, and will therefore have hundreds of dollars less each month to spend on restaurants, services, travel, new vehicles, entertainment, etc.
On the margin, there will be some homeowners who simply can’t afford the higher mortgage payments and are forced to sell. Combined with the fact that higher interest rates are already putting downward pressure on home prices, we expect to see real estate prices continue to soften over the next 6-12 months.
As we move forward into the unfolding “renewal crisis” and household discretionary spending gets eaten up by higher mortgage payments, the BoC will eventually pivot from fighting inflation into cutting rates to help ease the economy into a soft landing. So the wise investor or aspirational home owner should be patient, keep watching the market closely and be ready (and pre-approved) to jump on buying opportunities that might come up over the coming year.
What should I do if my fixed mortgage is coming up for renewal soon?
If you have a fixed rate mortgage coming up for renewal in the next 2 years, you need to start preparing immediately for much higher monthly payments. Start building up some reserves now if you can to help cushion the blow, and begin prioritizing your spending to the essentials. We would be happy to help you with a quick calculation of what you monthly payment could look like at renewal, so you can see how it will look against your household budget.
When you renew your mortgage, you should probably choose a shorter contract term (2 or 3 years). The interest rate will be higher than the 5 year option, but based on current data it looks likely that you’d be able to get a much better interest rate in 2025 or 2026 (such that you’d save a lot of money in the future to offset the extra bit of interest you’d pay over the initial term). Of course, everyone’s risk tolerance and budget needs are different, so please speak with us about your particular situation before you renew (you can schedule a no-obligation renewal consultation here).
Have questions?
We are always happy to discuss your financing needs!
Please book an appointment today with one of our broker team to discuss your plans and we’ll make sure you have all the information you need to make the best financial decision and get the best mortgage to reach your goals.
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