The Bank of Canada (BoC) has finally made an interest rate cut after more than two years of raising or maintaining interest rates. While a 25 basis point cut won’t significantly impact mortgage costs in the near term, it could have a substantial psychological effect on buyer and seller sentiment about the market.
How will the rate cut impact mortgages?
Fixed Rates
The BoC’s policy interest rate does not directly impact fixed mortgage rates, which are benchmarked against Government of Canada bond yields. The primary factor influencing bond yields is inflation: when inflation is high, bond yields increase, leading to higher mortgage rates; when inflation decreases, bond yields typically follow, resulting in lower mortgage rates.
While inflation drives both bond yields and the BoC’s decisions to adjust the policy interest rate, they operate at different speeds. Generally, fixed and variable rates tend to move in the same direction.
Variable Rates
The BoC’s policy interest rate directly changes variable mortgage rates, altering payments with each hike or cut. This 25 basis point cut will have only a minor effect on payments.
Example
Consider a $1,000,000 purchase with a 20% down payment on a 5-year term variable rate:
1) At 6.5%, the monthly payment would be $5,359
2) At 6.25%, the monthly payment would be $5,238
3) At 1.5% (the rate before the hikes began), the monthly payment would be $3,198
In the first two scenarios above, the difference in monthly payments is $121. This is insignificant when compared to the $2,161 less a family would have been paying at the start of 2022 (bullet #3 above).
As mentioned earlier, the importance of this rate cut lies more in its psychological impact and influence on market sentiment than in any significant dollar savings.
What happened in past rate cutting cycles?
In the years that followed the previous rate-cutting cycles in 2008, 2014/2015, and 2020 year-over-year average price increases ranged between 5% and as high as almost 33%.
I’m not saying that will happen this time, but history often rhymes. The chart below illustrates how a decline in interest rates has historically been followed by a period of rapidly rising prices and competition.
Waiting for rates to fall — a catch-22?
If a similar scenario occurs today, is it better to wait for rates to fall further (which will take time) or to buy now before prices appreciate and competition intensifies?
Many economists expect an additional 50 basis points of cuts by the end of 2024, bringing the policy rate to 4.25% by 2025. Assuming fixed rates fall in tandem with the policy rate, I want to look at a few simple scenarios to see if playing the waiting game would be the best financial option.
NOTE
The following scenarios are based on today’s average fixed mortgage rate of 5% with a 25-year amortization.
| Today | Scenario 1 | Scenario 2 | Scenario 3 | |
|---|---|---|---|---|
| Appreciation by 2025 | – | 10% | 5% | 5% |
| Purchase price | $1,000,000 | $1,100,000 | $1,050,000 | $1,050,000 |
| Down payment (20%) | $200,000 | $220,000 | $210,000 | $210,000 |
| Additional down payment | – | $20,000 | $10,000 | $10,000 |
| Mortgage balance | $800,000 | $880,000 | $840,000 | $840,000 |
| 5-year fixed rate | 5% | 4% | 4% | 3.5% |
| Monthly payment | $5,118 | $4,629 | $4,419 | $4,194 |
| Total term cost (60 months) | $307,080 | $277,740 | $265,140 | $251,640 |
| Mortgage savings over the term | – | $29,340 | $41,940 | $55,440 |
| Appreciation missed out on | – | $100,000 | $50,000 | $50,000 |
| Difference between mortgage savings and appreciation | -$71,660 | -$8,060 | +$5,440 |
Even in the most favourable scenario (#3) where rates somehow fall to 3.5% by 2025, and prices only appreciate 5%, you’d only be saving $5,000 by the end of your 5-year term when factoring in average sale price appreciation between now and the start of 2025.
Prices have already appreciated 5.8% in Toronto since the peak of the fall market in October 2023, despite some of the worst market conditions in the last 10 years.
Is 5% appreciation by 2025 out of the question? I don’t think so if we’re entering a rate-cutting cycle.
Are 3.5% mortgage rates likely by the start of 2025? Maybe if we’re lucky.
And when you factor the following factors when waiting for rates to fall and the potential of prices appreciation:
- Increased land transfer tax on a higher purchase price
- Coming up with tens of thousands extra for your down payment
- Carrying a higher mortgage balance over the life of the loan
- Increased competition when the market starts ramping up
Any benefits of a lower rate over the next five years quickly diminish, or at the very least, look riskier. Additionally, it’s important to remember that once you have a mortgage you can always refinance in the future to take advantage of lower rates while working with a smaller mortgage balance.
There is a saying in our industry…
“Marry the house, date the rate.”
These scenarios are just simple illustrations, so it’s essential to consider the specific price point, property type, and areas of the city you are buying or selling in. It definitely merits a more detailed conversation based on your unique situation.
If you have questions about your specific situation, need advice, or want to talk about what I’m seeing out there, get in touch. I’m always happy to talk shop!
