What the U.S. interest rate turning point means to Canadians

mortgage ratesDisentangling from the low-interest rate trap of the past 6½ years will be a slow and delicate process. Many of us are getting the house in order now.

After 80 months of central bank interest rates at or near zero, the low cost of borrowing shows signs of coming to an end.

The U.S. Federal Reserve ended a two-day policy meeting with Chair Janet Yellen giving notice of the first American interest rate hikes in almost a decade. Yellen said if the American recovery continues rates with rise this year.

Eventually, it will drag us along, though for now our central bank has no similar plan.

Economists foresee two quarter-point increases in the U.S. with the first coming in September.

At a Washington press conference, Yellen said the situation will be reviewed month-to-month, but all indicators point to strong job growth and a healthy economy. She urged Americans not to panic and “overstate the importance” of that first rate rise. Monetary policy will remain “highly accommodative” which is central banker language for easy credit.

What does that mean for us? First that disentangling the North American economy from the low interest rates of the past 6½ years is starting. It will be a slow and delicate process.

But the news makes clear that we’ve reached the turning point. The interest rate momentum which has been down since 2008 is changing direction.

That means it’s a good time to get the house in order, lock-in a mortgage, repay some of that debt.

The flood of money pouring into real estate and stocks has pumped up prices of both assets and given us an illusion of wealth. It has encouraged us to spend more because we feel better. This in turn has created demand which has helped create jobs and company profits.

But as rates rise the effect will be reversed. House and stock prices fall, or fail to keep rising, we will gradually feel a little less well off, reduce spending and so demand and profits fall.

The trick for central bankers is to raise rates enough to slow, but not kill the economy.

The Bank of Canada reiterated last week in its semi-annual financial system review that the steady advance in house prices, goosed by the January rate cut, is the biggest risk to our financial system. It is also worried about stock prices rising out of line with historic measures.

Even so, the Bank did not change its stance which is to leave rates alone.

The hypocrisy aside – who’s keeping rates at these levels, after all – many consumers are paying attention and getting the house in order literally, while the going is good.

A survey by Manulife Bank of Canada this week finds 40 per cent of homeowners are whittling away at their mortgages ahead of schedule. Manulife found that 18 per cent made extra lump-sum payments in the past year, while 17 per cent increased their regular payments which reduces amortization. Another five per cent did both.

The annual survey of home buying habits by the Canadian Association of Accredited Mortgage Professionals (CAAMP) finds the same thing. CAAMP finds first-time buyers are on average putting 21 per cent down and expect to tighten up amortization periods from 25 years to 20 by increasing their payments.

The flip side is that the Manulife survey also found that a third of homeowners would face hardship if their mortgage payments increased by just 10 per cent. Four in 10 would struggle to make their mortgage payment within three months of a job loss.

So, the tipping point for some isn’t that far away.

Peter Drake, a former TD Bank economist and vice-president of economic research at Fidelity Investments Canada, believes it will be “hard, but not impossible” to ease into a higher interest rate world. But those with the least wiggle room will suffer.

“As rates rise, some people will be caught out. They always are,” he says.

Drake says rising rates are not a reason to panic, but an opportunity to take stock.

“It’s a question of looking at what’s good for you. Housing prices have gone up a lot. Is it time to be cautious? Yes, it’s cheap to borrow now, but if rates go up what will happen?”

That sort of thinking is good advice. A little planning now can go a long way later.


A homeowner debt snapshot

Manulife Bank asked 2,400 people between 20 and 59, with household income over $50,000 about debt

  • 78% said being debt-free is a high priority.
  • 56% reduced their debt in the past year.
  • 20% increased their debt in the past year.
  • 40% reduced their mortgages ahead of time with an average payment of $6,300.
  • 79% said they would cut discretionary such as dining out to become debt-free sooner.
  • 17% said they’d struggle to make a mortgage payment one month after losing a job.

By: Adam Mayers Personal Finance Editor, Published on Thu Jun 18 2015

Comments are closed.