Can mortgage rates go to zero?

by on 23 Nov 2021

As many of us know, the real estate industry has been experiencing a significant boom in the last year and a half. Housing prices have been skyrocketing meaning that mortgages are often at the top of the mind when buying a house. The mortgage interest rate of your home is an important factor when it comes to financing a house, so it's beneficial to keep an eye out for the best rates.

While mortgage interest rates have been on a slight uphill climb recently, you might be wondering what happens if interest rates ever reached zero or dip into the negative. Let's take a look at this concept and break down how it could affect the real estate industry.

How interest rates are set

In order to understand zero and negative interest rates, it's important to understand how rates are set and how they affect mortgages in general.

The role of the central bank

While interest rates can seem random and extremely variable to the common eye, setting an interest rate is actually more complex than you may think. The key piece in the puzzle of setting interest rates is the central bank. In Canada, the central bank is The Bank of Canada while the Federal Reserve (commonly referred to as the Fed) is the central bank in the United States.

The benchmark rate

In basic terms, the central bank sets a key interest rate, also known as the benchmark rate, that banks and other lending institutions can borrow money at. Because banks are considered to take more safe or stable loans, their borrowing interest rates are lower than the rates that they set for themselves. The central banks also set their overnight rate which is the rate at which banks and other lenders can borrow money between each other.

When these banks have borrowed money, they set their own interest rates that borrowers like homeowners and students can borrow at. The key interest rate from the central banks acts as a benchmark interest rate and many banks and other lenders set theirs higher than this. This is to cover their own borrowing costs. In other words, if the banks were to lend you money at an interest rate that is lower than the overnight rate, they would be losing money.

Current mortgage interest rates

Mortgage rates are currently ranging from around 2-4% depending on the bank and the type of mortgage. The top five big banks currently have variable mortgage rates starting at 2.5% and some five-year fixed rates reaching 4.79%.

Recent market forecasts suggest that rates will continue to increase in 2022 as the economy and the financial system continues to deal with the effects of the pandemic.

Monetary policy

Another role that the Bank of Canada and the Fed have is promoting economic growth by using monetary policy, which is a toolkit used to promote growth and keep credit flowing by controlling the amount of money available to banks, businesses, and other consumers. The economic conditions can affect everything from the price of your groceries to your saving rates to your business credit card rates.

One of the tools in this toolkit is the rate at which the banks lend money to other banks. When the central banks' rates change, other banks, businesses, and lending institutions also change their rates to adjust to the difference.

Often, when rates are low, there will be an increase in demand and spending among consumers as they can take out cash loans with lower rates. This sparks economic growth and prosperity.

Declining and increasing interest rates

In personal finance and economics, it's understood that the economy and interest rates have an inverse relationship. This means that when interest rates are low, inflation rises and the economy grows. On the opposite side, when rates are high, inflation decreases and the economy will decline.

Often, extremely low rates occur after a global financial crisis as a form of economic recovery and to get the financial sector on stable ground. For example, for the four-five years after the Great Recession and the fall of the housing market, there were extremely low-interest rates as a way to boost economic spending and borrowing.

Will mortgage rates go to zero?

While some countries have been adopting negative mortgage rates, it's likely that Canada will not have rates that reach or dip below zero. Seeing as even the most secure home buyer still carries some risk, it would be tricky for banks to offer these kinds of low-interest rates to potential buyers.

As well, because of the boom that the real estate industry is experiencing, negative interest rates are less likely to appear right now.

What are negative interest rates?

 person entering percentage into calculator

The COVID-19 pandemic: a low-interest rate economy

At the start of the Coronavirus pandemic in 2020, many mortgage rates started to decline as homebuyers navigated the workplace while at home. The central bank pushed interest rates to record lows. This low-interest rate environment was done to support consumers during the global crisis. Particularly, the federal funds rate was extremely close to 0% as a way of promoting economic recovery and ensuring that individuals could continue to pay interest on their loans.

Many banks and lending institutions had record low rates that were hovering above negative territory. While many industries were experiencing declines and dips, the housing industry experienced a boom at the same time. The boom was sparked by the combination of the pandemic's lower rates, the increase in buyers, and the decrease in supply.

Negative rates

If interest rates turn negative, it would enable the housing boom to continue to grow as the cost of a mortgage would become more affordable. In short, borrowers could purchase houses and take out mortgages at negative interest rates and could go without paying interest on their loans for two decades. The buyer's debt would be made up entirely of the principal mortgage and the bank would technically pay you to take out a cash loan.

On the other hand, rising mortgage rates will cause the boom to burst as homeowners as monthly payments get higher and higher.

Since the market has started to cool, it can be assumed that the mortgage rates will increase rather than decline or hit below 0%. Real estate investors will likely see that the rates are increasing and pause their spending in the housing industry.

What's next for the housing market?

While it's impossible to dictate exactly what will happen in the real estate industry, there are some market forecasts and predictions that can be used to plan ahead.

Forecasted mortgage rates

With the real estate industry boom beginning to cool, this brings with it higher mortgage rates. Higher rates means buyers will perhaps be less likely to buy a new home as it would mean more interest being paid on their mortgage.

Banks tend to look at the five-year fixed rate for bond yield when setting the mortgage rates. Bonds are up this year and the yields have started to increase again, which means it is likely that mortgage rates will rise with them.

Because the economy is well on its way to recovery after the last two years, it's likely that mortgage rates will continue to rise and the real estate market will level out. This can also mean that buying a house right now will actually lose you money. Prices are skyrocketing, but when the market levels out, the same house you buy now, may not be worth as much in the next few years. This is something for investors to consider in the next few months.

Increased rates can mean fewer buyers

With higher mortgage rates, there will likely be fewer buyers looking to enter the real estate market. While it was a profitable decision to sell and buy real estate with low rates, a higher average rate can mean that individuals will slow down their spending. This would mean that the demand for houses will go down, but the supply could increase, creating the exact opposite of the current situation.



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