Interest Rates and 2014

The Canadian mortgage market favours five year fixed rate term renewals, and as such the prospects for those looking to renew mortgages in the coming year matters for inflation as well as credit growth. A borrower has a few options at renewal time, including continuing to amortize a loan on its original schedule, refinancing for a different loan amount, and changing between fixed and variable rate over various terms. Now-retired "Vancouver Housing Blogger" brought us the concept of the "renewal gap", the interest rate differential a borrower sees upon mortgage renewal, shown below for the 5 year fixed rate mortgage using the "average residential mortgage rate" as reported by CMHC, and the "posted" rate as reported by the Bank of Canada (note current rates are held as constant indefinitely into the future):

Extending this concept further, we can look in terms of change in payment, which depends upon whether a borrower refinances or re-amortizes. The four scenarios considered are:

• Borrower refinances a 5-year amortized $100,000 loan into another $100,000 25 year amortization loan (and pocketing the amortized amount) (blue line)
• Borrower refinances a 5-year amortized $100,000 loan into a $100,000 20 year amortization loan (and pocketing the amortized amount) (red line)
• Borrower continues a 5-year amortized $100,000 loan into a 25-year amortization loan (ie extends the amortization only) (yellow line)
• Borrower continues a 5-year amortized $100,000 loan into a 20-year amortization loan (ie continues the amortization schedule; this would be the scenario for a borrower who wants to continue with a government-insured policy loan) (green line)

The four scenarios are graphed below for the average lending rate, again assuming current rates are extended indefinitely into the future:

The blue and green lines overlap exactly. That is, a borrower deciding to refinance a $100,000 loan for 25 years or continuing to finance a loan five years into its 25 year amortization for 20 years is the same. If a borrower decides to refinance but not re-amortize, that results in a higher payment, and if a borrower decides not to refinance but to re-amortize, that results in the lowest payment in the scenarios considered.

Starting in 2012 and continuing all the way until today, all four scenarios resulted in lower mortgage payments compared to the previous five year term. Starting in early 2014, that scenario quickly changes, with only the re-amortization scenario offering any significant easing of payments. The sudden change in payment terms for borrowers will tend to reduce credit growth and yet be relatively inflationary through most of 2014 and all years hence, barring any significant drops in mortgage rates.

Canadian and US Bond Yields

The perpetual threat of rising bond yields that (one assumes) translate to higher mortgage rates are back in the news. Well, rising US yields are in the press, anyways, and we all know that Canadian yields are tightly linked to US bond yields.

The graph below shows the linear spread between Canadian and US 10 year bond yields (ie the Canadian 10Y bond yield minus the US 10Y bond yield) since 1955:

When we say Canadian and US yields track, it is in the statistical context.

Teranet House Price Index - Home Prices Down in November

HOME PRICES DOWN 0.1% IN NOVEMBER

In November the Teranet–National Bank National Composite House Price Index™ was down 0.1% from the month before, essentially reversing the October gain. Because prices in November 2012 had declined by a greater margin, 12-month home price inflation accelerated to 3.4% from 3.1% in October. The rise from a year earlier exceeded the cross-country average in five of the 11 metropolitan markets surveyed for the index: Calgary (5.9%), Hamilton (5.2%), Toronto (4.2%), Vancouver (3.9%) and Quebec City (3.7%). The 12-month gain lagged the average in Edmonton (3.0%), Winnipeg (2.8%), Ottawa-Gatineau (1.2%), Halifax and Montreal (0.8%). Prices were down from a year earlier for a ninth consecutive month in Victoria (−1.4%).

Teranet – National Bank National Composite House Price Index™

The 0.1% monthly decline of the composite index was the fourth November decline in a row. Be it as it may, since November prices have on average gained 0.1% from the month before over the 15 years of data index collection, this year’s retreat does not signal a buoying market. Prices were up on the month in four of the 11 metropolitan areas: Vancouver and Halifax (0.6%), Hamilton (0.3%) and Winnipeg (0.1%). The Winnipeg gain was the first in five months. Prices were down from the month before in Victoria (−1.8%), in Montreal (−0.6%), in Calgary (−0.3%) and in Edmonton, Quebec City, Ottawa-Gatineau and Toronto (−0.2%). Vancouver prices have been rising for seven straight months, reaching a new record in November. However, prices in six of the 11 markets have been trending down recently: for four consecutive months in Quebec City (total −1.8%), Montreal (−1.4%) and Edmonton (−1.1%); for three consecutive months in Ottawa-Gatineau (total −0.8%). Prices have declined 0.4% in Toronto over the last three months and 2.4% over the last two months in Victoria. Despite November’s increase, prices are down 0.7% over the last five months in Winnipeg.

Teranet – National Bank House Price Index™

The historical data of the Teranet–National Bank House Price Index™ is available at www.housepriceindex.ca.

Metropolitan area	Index level November	% change m/m	% change y/y
Calgary	172.23	-0.3 %	5.9 %
Edmonton	171.19	-0.2 %	3.0 %
Halifax	142.07	0.6 %	0.8 %
Hamilton	147.03	0.3 %	5.2 %
Montreal	149.65	-0.6 %	0.8 %
Ottawa	142.39	-0.2 %	1.2 %
Quebec	176.42	-0.2 %	3.7 %
Toronto	153.50	-0.2 %	4.2 %
Vancouver	174.04	0.6 %	3.9 %
Victoria	136.22	-1.8 %	-1.4 %
Winnipeg	193.82	0.1 %	2.8 %
National Composite 6	158.53	0.0 %	3.5 %
National Composite 11	159.21	-0.1 %	3.4 %

The Teranet–National Bank House Price Index™ is estimated by tracking ob­served or registered home prices over time using data collected from public land registries. All dwellings that have been sold at least twice are considered in the calculation of the index. This is known as the repeat sales method; a complete description of the method is given at www.housepriceindex.ca.

The Teranet–National Bank House Price Index™ is an independently developed representation of average home price changes in six metropolitan areas: Ottawa, To­ronto, Calgary, Vancouver, Montreal and Halifax. The national composite index is the weighted average of the six metropolitan areas. The weights are based on aggregate value of dwellings as retrieved from the 2006 Statistics Canada Cen­sus. According to that census¹, the aggregate value of occupied dwellings in the metropolitan areas covered by the indices was $1.168 trillion, or 53% of the Canadian aggregate value of $2.207 trillion.

All indices have a base value of 100 in June 2005. For example, an index value of 130 means that home prices have increased 30% since June 2005.

By :

Marc Pinsonneault Senior Economist Economy & Strategy Group National Bank of Canada

Teranet - National Bank House Price Index™ thanks the author for his special collaboration on this report.