Tuesday, August 20, 2013

Update on mortgage rates

Since the 5 year Government of Canada bond yield recently touched the psychological 2.0000% barrier I thought I'd update mortgage rates first from a historical perspective and second by looking at the "renewal gap" and relative payment ratios based on average mortgage rates to the end of July.

The 5 year Government of Canada bond yield:

Residential mortgage rates, using "posted" and "average" rates. Average rates through July 2013 have not increased significantly, meaning the spread to risk-free has dropped by about 70bps on the chart below.

The five-year "renewal gap" is the interest rate differential (IRD) an owner would receive renewing a mortgage at various points in time, with the most recent mortgage rate held constant into the future. After 5 years this would obviously mean a renewal gap of 0 bps. The renewal gap does not yet capture potential mortgage rate increases (since the last reported average rate is still low), nonetheless even with the most recent increase in rates, and assuming rates do not significantly increase further, the renewal gap will remain negative for the remainder of the year, with a near-zero renewal gap manifesting in May 2014.

The chart below holds income and debt-service ratio (DSR) constant and looks at how much loan a borrower can afford over time, aligned with changes to maximum amortization lengths. This assumes uninsured borrowers can still secure 30 year mortgages. If the predominant maximum offered amortization length becomes 25 years I will adjust this, which would kick the blue line down to about 155.
Even with the most recent increase in rates, households with five year fixed mortgages still have room to refinance at terms more favourable than five years ago.