To lock or not to lock? Is it time to switch to a long-term rate?

A year ago I wrote an article and stated that no one would blame you if you were overcome with a pending sense of doom just by reading the headlines. Here we are a year later and I feel like I can pull out the same article and just change the date on it.   

We once again find ourselves in a situation whereby simply reading the headlines is enough to make the strongest optimist feel a little pessimistic about where the economy is heading.

Mark Carney, the Governor of the Bank of Canada, recently spoke to the Vancouver Board of Trade with warnings that there is a risk that 'fear and greed' driving real estate prices to unsustainable levels.

At the same time, Ben Bernake, Carney's counter-part with the U.S. Fed, was preparing to put an end to an unprecedented era of quantitative easing in the U.S. - meaning the U.S. government is going to stop printing money to bail out bad loans.

What does all of this mean to you as a Canadian home owner or real estate investor? For most consumers who either have a mortgage or are looking to get one - the question inevitably comes back to: how does all of this impact interest rates?

The answer lies slightly beyond the headlines. It is no secret that the current low interest rate environment that we've been enjoying for the past three years must come to an end eventually and start to make its way upwards to what is referred to as a 'Neutral' rate zone of a prime rate at 5 - 6%. The age-old (or in this case three year old) question is not if but when? Canada's Central Bank is trying its best to suggest that those rate increases could be sooner rather than later.

They have used particularly strong language to 'warn' Canadians about the impending rate hikes. Carney repeated his warning to Canadians about becoming overextended:

"It's important that it's emphasized, because it can be forgotten that we are living in extraordinary times with interest rates that are unusually low,... that rates are not going to stay at these unusually low levels. And so Canadians need to ensure that they can continue to service those debts comfortably in a higher-rate environment."

It's clear that Carney is starting to show some frustration that although he's been warning against Canadians taking on too much debt at these low rates for over two years now, his words appear to be falling on deaf ears. House prices have risen in most Canadian cities (Calgary and Edmonton being the rare exceptions) by an average of 8.6% with Vancouver leading the way at a year over year increase of 25.7%. This combined with a record level of household consumer debt fuelled by a prolonged period of record low rates and it's no wonder the Central Bank Governor feels that 'We're not getting the message.'

But this is where it gets interesting. Given his comments, one would expect the Bank of Canada to start raising rates soon in an effort to cool down the housing market. But it's not that easy. We still have to look at what's happening south of the border.

Ben Bernake made it clear in recent comments that, although he will stop the asset purchase program that was designed to help get the U.S. economy back up on its feet, slower than expected job growth (partly due to the ripple effect of the Japanese earthquake) has resulted in the need for continued monetary stimulus in the U.S. economy, which is lacking a confi dent consumer base to pull it out of its recession.

This translates into a further extension of low rates in the States. It now appears that Bernake will not make a move in rates until 2012. Mark Carney has stated that Canada cannot deviate too much for too long from the U.S. because of the effect that would have on the Canadian dollar.

So essentially we have a situation whereby the Bank of Canada would like to raise rates to slow down our borrowing habits.

But to do so would mean a separate monetary policy than the States, cause the Canadian dollar to rise and potentially hinder the economic recovery as a whole. Further compounding Carney's dilemma (especially in the Vancouver market) is the influence of the foreign investors who represent a key driver behind the surging market values.

Raising rates will have little or no impact on those buyers and will only serve to hurt the domestic buyer. So Carney may look to Jim Flaherty and the Finance Department again to provide the solution as they have for the past two years.

Having the Finance Department make it more difficult for some Canadians to get a mortgage may be a more appropriate tool than to raise rates. As we enter into the final quarter of 2011 we find ourselves in territory similar to where we were in 2010.

We know rates have to start going up but certain factors keep preventing them from doing so. Those factors are the usual suspects: The stalled U.S. recovery, global uncertainty, European debt crisis and the Canadian dollar. Rates will eventually go up, but in the meantime, we continue to benefit from yet another prolonged period of a low rate environment. My warning to you today is the same as it was a year ago.

The market has given you a gift - how are you going to use it? In the midst of all this talk about the Bank of Canada, one very important element gets missed. The BOC can only control the prime lending rates. The long term rates are governed by the Bond markets. A drop in bond yields has resulted in another wave of record low long term rates as well.

If all this talk of global uncertainty concerns you or you simply don't want to have to guess what Mark Carney's next move is going to be, there has never been a better time to lock into a long term rate and simply forget about it - knowing that you have a fixed low cost of borrowing and you can sleep well at night. For the rest of you, stay tuned. There's bound to be more exciting headlines to share in the months ahead.


For more in-depth analysis on the economy, subscribe to Canadian Real Estate magazine or pick up a copy of our September issue on newsstands now.


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