Canadian Mortgage Rates Set to Skyrocket

After a long period of relatively stable mortgage rates, we may be heading in the other direction.Bond yields have been rising, and that's important because Government of Canada bond yields heavily influence the fixed mortgage rates offered by Canadian lenders.If yields continue moving higher, five-year fixed mortgage rates are likely to follow.For an already struggling real estate market, that's another challenge.Higher mortgage costs reduce how much buyers can afford to borrow. And when buyers can borrow less, something eventually has to give.Usually, that's price.

Why Bond Yields Matter to Your Mortgage

Most Canadians are familiar with the Bank of Canada because changes to its overnight rate directly influence variable-rate mortgages.Fixed mortgages work differently.Three-, five- and ten-year fixed mortgage rates are heavily influenced by Government of Canada bond yields of similar durations.Recently, the five-year Government of Canada bond yield has climbed to approximately 3.65%.Banks obviously don't lend money at the same rate as the government. They add a spread to cover their costs, risks and profit.That means a five-year bond yield in this range can translate into mortgage rates considerably higher.Over the past 18 months, we've regularly seen five-year fixed mortgage rates somewhere around 3.99% to 4.29%.If bond yields remain elevated or continue climbing, we could see fixed mortgage rates moving closer to 4.5% and potentially toward 5%.

Why Higher Rates Put Pressure on Home Prices

This is where mortgage rates and real estate prices become directly connected.Most buyers don't walk into a bank and simply decide how much they want to spend on a house.Their maximum purchase price is heavily influenced by how much income they earn and how large a mortgage they can qualify for.When mortgage rates increase, the same monthly payment supports a smaller mortgage.If enough buyers suddenly have less borrowing capacity, sellers eventually have to adjust to what those buyers can afford.That's one of the reasons higher interest rates can put downward pressure on home prices.And in Greater Vancouver and the Fraser Valley, that's happening at a time when prices are already declining.

Lower Home Prices Don't Necessarily Mean Better Affordability

This is probably the most frustrating part for buyers.Suppose home prices continue falling because mortgage rates are rising.The house itself may become cheaper, but your monthly carrying cost might not improve very much.A lower purchase price combined with a higher interest rate can produce a surprisingly similar monthly mortgage payment.So when people say falling prices automatically make housing more affordable, it's not quite that simple.True affordability depends on both the price of the home and the cost of financing it.

There Is Still an Advantage for Buyers

There is, however, one major benefit to lower home prices.Your down payment is based primarily on the purchase price, not the monthly mortgage payment.If prices continue declining, the amount of cash required to purchase a home can also decline.That's particularly important for first-time buyers who may be perfectly capable of handling the monthly payment but have struggled to save the enormous down payment required to enter markets like Surrey, Langley and the rest of the Fraser Valley.Lower prices can shorten that savings hurdle.Buyers may also benefit from greater selection, more negotiating power and less competition than they faced several years ago.

What About Variable Mortgage Rates?

Variable-rate mortgages are tied more directly to the Bank of Canada's overnight rate rather than Government of Canada bond yields.So rising bond yields don't automatically mean your variable mortgage rate immediately increases.But bond markets can reflect expectations about future inflation and interest rates.If inflation becomes a bigger problem again, the Bank of Canada could eventually be forced to increase its overnight rate.That would push variable mortgage rates higher as well.There is no guarantee that happens, and predicting exactly where rates will be six or twelve months from now is extremely difficult.But anyone choosing between fixed and variable today should at least consider what happens to their finances if rates move higher rather than lower.

What Does This Mean for Sellers?

For sellers, higher borrowing costs create another potential headwind.I've been saying for some time that in a declining market, waiting can be expensive if you already know you need to sell.If prices continue falling while borrowing costs rise, the pool of buyers able to afford your property can become smaller.That doesn't mean everybody should immediately sell their home.If you have no intention of moving, short-term fluctuations in market value may not matter much to you.But if you already expect to sell within the foreseeable future, assuming that simply waiting a few years will automatically produce a higher price is becoming increasingly difficult to justify based on current market conditions.

The 2022 Buyers Could Face a Difficult Renewal

There is another group I'm watching particularly closely.Buyers who purchased near the peak of the market in early 2022 and took five-year fixed mortgages will begin approaching their renewals in 2027.Some of those homeowners purchased at extraordinarily high prices while benefiting from much lower mortgage rates.If they renew into significantly higher rates while their property is worth less than they originally paid, that could create a difficult financial situation.It doesn't mean those homeowners will automatically be forced to sell.But for households already operating with tight budgets, a substantially larger mortgage payment could become a serious challenge.That's why I think homeowners with renewals approaching should start looking at the numbers well before their mortgage actually comes due.

Should You Lock In a Mortgage Rate Now?

There isn't one answer that works for everyone.Locking into a fixed mortgage provides certainty. You know your payment and interest rate for the term and don't have to worry about short-term fluctuations.A variable mortgage may initially offer a lower rate, but you're accepting the possibility that the rate could increase.The right decision depends on your finances, tolerance for risk, mortgage terms and how long you expect to own the property.But if your household finances would become uncomfortable with mortgage rates closer to 5%, that's something worth understanding now rather than discovering at renewal.

Falling Prices Will Create Winners and Losers

Higher mortgage rates combined with falling real estate prices aren't automatically good or bad for everybody.For a seller who needs to sell, continued price declines are obviously difficult.For an existing homeowner with no plans to move, they may be largely irrelevant.For a first-time buyer, lower prices could reduce the down payment required to enter the market, even if monthly payments remain high.And for someone selling a smaller property to move into a larger home, declining prices can sometimes work in their favour if the more expensive property falls by a greater dollar amount.That's why I'm hesitant to simply describe today's market as good or bad.What matters is what the market means for you.

Don't Wait Until Your Mortgage Forces the Decision

The biggest takeaway isn't that everyone should sell, buy or immediately lock into a five-year mortgage.It's that the direction of borrowing costs matters.If you have a mortgage renewal coming, understand what your payment looks like at higher rates.If you're thinking about selling, understand what continued downward pressure on prices could mean.And if you're buying, don't look only at the sticker price of the home. Look at the purchase price, down payment, mortgage qualification and monthly carrying costs together.Real estate prices may continue coming down.But if they're falling because financing is becoming more expensive, that doesn't necessarily mean owning a home suddenly becomes cheaper each month.Understanding that distinction can help you make a much better decision about what comes next.

Written by:
Steve Karrasch PREC
Karrasch Real Properties Team
Macdonald Realty