Canadians feel little pain of rate hikes – so far

Canadian consumers are feeling little pain from four rate hikes by the Bank of Canada, despite all warnings to the contrary, with most escaping higher monthly mortgage costs, others priced out of home buying altogether, and many enjoying income gains.

Data released on Friday showed retail sales rose 2 per cent in May and are on track to expand at an annualised pace of about 4 per cent in the second quarter, defying predictions that rising interest rates would douse the long consumer boom.

While official interest rates have risen 1 percentage point in a year, analysts said the structure of Canada’s mortgage market means few borrowers have felt the rate hikes, and those priced out of the market are now spending their money elsewhere.

“Somewhere between 10 per cent and 12 per cent of mortgage holders are actually in a product that is going to be affected by a rate increase,” said Paul Taylor, president and chief executive at Mortgage Professionals Canada.

More than seven in 10 mortgages have a fixed interest rate, Taylor said, while the others are split between adjustable and variable rate mortgages. While adjustable rate mortgages see higher monthly costs when rates rise, variable rate mortgages typically come with fixed monthly payments.

That means borrowers simply pay more interest and less principal when rates rise, and the length of their mortgage term is bumped out by a few months, said Rob McLister, founder of mortgage rate comparison website RateSpy.com.

“So their monthly cash flow stays the same,” McLister said, noting that Canada’s big banks, which hold about half of Canadian mortgages, typically offer fixed-payment variable mortgages.

What’s more, while about half of Canadian mortgage holders will see their interest rate reset this year – including those whose fixed-rate mortgages renew – those who signed up for the most popular product, the 5-year fixed rate, will find their rates nearly identical to 2013 levels.

According to rate data provided by McLister, the discounted 5-year fixed rate was about 3.25 per cent in June 2018, up just 30 basis points from 2.94 per cent in June 2013. The five-year change in other months was even smaller.

“A one percentage point change in the overnight rate should be pretty meaningful to households, but they don’t borrow at the overnight rate – a lot comes tied to the five-year yield … and their monthly cash flows don’t really look any different,” said Royce Mendes, senior economist at CIBC Capital Markets.

The Bank of Canada said last week that while wage growth has improved, a slowdown in the growth of total hours worked and the new mortgage rules are expected to weigh on consumer spending. The tighter rules, which took effect in January and pushed many first-time homebuyers out of the market, have also helped slow the growth of Canada’s huge household debt.

Taylor said the new mortgage limits have dashed the home-buying dreams of many middle-class Canadians, which is bad for the economy in the long run. But he admits the change has probably been good for consumer spending.

“If you’ve been saving for a down payment for years, and now you need another C$20,0000 or C$25,000 just to qualify for a mortgage, you give up. And the idea of a new car feels like a pretty good reward instead. So I’m not surprised there’s an uptick in consumer spending if people no longer have the opportunity to invest in housing.”