Here is a great blog post from a colleague and high school friend in Ontario in response to the Bank of Canada decreasing the overnight lending rate, but the banks not following suit.

A great read!

Interest Rate Update – January 23, 2015

The Bank of Canada surprised almost everyone by cutting the overnight rate by 0.25% earlier this week in response to the recent drop in oil process, which it expects will have a negative effect on the growth of the economy and inflation.

This is contrary to what almost every media outlet has been reporting for the last five years – that low interest rates are short lived. Even the Bank of Canada has used strong language since September 2010, the last time they changed the overnight rate, stating that interest rate increases were inevitable and at times, imminent.

I have spent the better part of the last five years informing my clients that until Canada exhibits some real job creation and sustained inflation of over 2%, interest rates could not go up. While I did not expect them to drop this early in the year, I have included in some recent updates that looking at the data, interest rates should actually be dropping instead of climbing. I do believe that the only thing that held the Bank of Canada from dropping interest rates earlier was their belief that they would lose credibility after years of rate increase warnings. The steep drop in oil prices gives them a diversion to take attention away from the reality that they should have cut the rate a year ago.

Here is where it gets tricky. The banks are under no obligation to alter their ‘prime’ lending rates when the overnight rate changes. There is precedent to this. In early 2002, the Bank of Canada dropped the overnight rate by .50%, however the banks only followed with a .25% cut to the prime rate. The historical 2.00% spread between the two rates has been a 1.75% spread ever since. Guess who is pocketing that extra .25%? (Hint – it’s not you).

Since Wednesday’s announcement, not one bank has cut their prime rate to match the cut by the Bank of Canada. This is not to say that they won’t, but in my 16 years of sending out interest rate forecasts to my clients, I have never seen this long of a wait before the banks follow with a rate cut. And as one of my clients mentioned today, if the rate had gone up instead of down, you can bet it wouldn’t be 48 hours before we heard anything from the banks.

Actually, we did hear from one bank. TD Canada Trust issued a statement a few short hours after the Bank of Canada announcement stating that they would not be cutting their prime rate. As most of you know, I have a special place in my heart (not a good special place) for TD. This is the same bank that sent notices out to tens of thousands of their clients in 2009 informing them of a 1.00% increase in their line of credit rates and also the same bank that was ‘featured’ on CBC’s Marketplace regarding their practice of not disclosing to their clients that they weren’t actually taking out mortgages on their homes, but restrictive collateral loans. See http://www.teamdugganmortgage.com/busting-the-banks If you follow the link to the video, skip ahead to the 8 minute mark.

Several media outlets, financial writers, and even some brokers have been reporting that variable rate mortgage payments will go down with the overnight rate cut. As mentioned above, it is not automatic. I tell everyone that asks that I am on the variable rate as well, and for the sake of paying my mortgage off faster I hope that my lender does follow with a .25% rate cut —- but until one bank blinks, and I hope one does, there is no change to report to variable rate mortgage holders.

With respect to fixed mortgage rates, their costs are set by the Canadian Benchmark Bond Yields. When yields go up, so do the fixed rates. When the yields go down, the fixed rates should go down too. But let’s take a look at recent activity in the bond market. The 5 year benchmark bond yields have shown a steep decline since mid December — almost .50%, yet the fixed rates at the banks have only dropped by .05% to .10% in the same time period. Again — guess who is pocketing the difference. (Hint – it’s still not you).

Going forward, there are going to be further hiccups along the way as the effect of lower oil prices and stagnant job growth works its way through the economy. This is going to keep mortgage rates, both the variable and the fixed rates, low for the foreseeable future.

I recommend that if you are on the variable rate mortgage that you stay on it for now. If you are buying a home or have a mortgage coming up for renewal this year, we need to have a longer conversation regarding the variable vs. fixed rate as there have been many changes to some key features of each type of mortgage over the last 5 years with the new government guidelines. I will probably be sending more frequent updates in the coming months as we enter into uncharted territory with respect to the bond yields (and I literally mean uncharted – the yields have never been this low).

In the meantime, stay warm, don’t believe everything you read in the newspaper, and feel free to forward this update to anyone that you think might be interested. As always, I am happy to answer any questions that you might have about interest rates in general and specifically about your own mortgage.

Your mortgage expert,

Patrick Duggan