If you have a mortgage, then interest rates are extremely important to you! When rates go up, mortgages become more expensive. When interest rates go down, keeping up with a mortgage becomes much easier. The problem is that you’re not just getting a mortgage based on today’s rate – your mortgage will be subject to rates that change over time, often over decades.
As a result, it’s important to know if mortgage rates are going up or down. This is a really hard question to answer, but there are a few things we can explain that might help you. We’re talking about mortgage rates in this article, but a lot of these rules apply to other types of interest rates, and we’ll use the terms interchangeably.
How to tell if interest rates are going up or down
It’s extremely hard to know for sure if rates will rise or fall, but there are ways to make educated guesses. Knowing whether mortgage rates will rise or fall comes down to understanding the state of the national economy, the world economy, and the current social and political circumstances you find yourself in.
That sounds complicated, we know, but don’t fret. Below we’ve explained some of the main factors that affect interest rates and what to look for in each one. Consider each of the factors below and you should get a pretty good idea of whether mortgage rates are rising or falling.
How banks set mortgage rates (the cost of lending)
At their core, mortgage providers are retailers. They offer a service that they sell for more than it costs. Instead of ”buying” a mortgage, you’ll pay a given interest rate for the service over time, which has to account for a lender’s costs, plus any profit it plans to make.
The main cost your bank needs to account for is the “funding cost”, which is the cost of borrowing the money that it will lend to you (yes, that’s generally how it works). Even if, hypothetically, the bank funded your mortgage with cash it had on hand, that money will be tied up in your mortgage instead of some other investment. In that case, the funding cost is an opportunity cost, the amount that it lost by investing in you and not elsewhere.
On top of the funding cost, mortgage providers need to earn enough to cover operating costs: staff, real estate, dividends to shareholders, etc. It also needs to make a certain amount of profit, which has to be enough to account for the risk that some borrowers will default on their mortgages (not you, of course).
Of course, these costs are variable, and change over time. To understand why that is, you’ll need to look at the wider economy.
Economic conditions (here and overseas)
Credit is like many other commodities in that it is also subject to supply and demand. When everyone wants to borrow money, the cost of credit is pushed up, increasing rates. When no one wants to borrow money, the cost of borrowing becomes cheaper. Most of the variation in demand for credit comes from commercial borrowers.
Generally speaking, when the economy is good, more businesses want to borrow money to expand their enterprises, so demand for finance increases and interest rates rise. Conversely, when the economy is performing poorly, demand for finance decreases, which sees interest rates drop.
The global economy also matters, especially that of the United States. The global economy is highly interconnected, and many Canadian banks borrow money from international sources, especially US Banks. This sort of relationship exists in most countries, although the details may change. Because of this, economic conditions overseas can directly affect the cost of borrowing at home, and vice versa.
The Bank of Canada’s impact on mortgage rates
One of the most important influences on mortgage rates is the Bank of Canada’s interest rate. A change to the Bank of Canada’s rate generally results in an equal adjustment to the prime rates of mortgage providers, although not always. This is because the Bank of Canada is a reserve bank, backed by the federal government.
Unlike the retail banks, the Bank of Canada tends to change rates proactively, rather than reactively. If there’s an economic downturn coming, the Bank of Canada will often cut rates early on. Cutting rates makes it cheaper to borrow money, which stimulates economic activity. Conversely, the Bank will increase interest rates if inflation is getting too high, for the opposite reason.
Variation between banks
Some rate variation between lenders is natural, as each bank is comfortable with different exposure to risk, have different overhead costs (especially digital-only lenders), as well as different marketing campaigns.
Generally speaking, to remain competitive, most lenders will follow the general trends of the market. There are times though that will see the banks move in an unexpected direction. For example, the Bank of Canada cut its rate to 0.25% in the early days of the COVID-19 pandemic. While banks did drop their rates as well, they soon increased mortgage rates again. This was because the pandemic, alongside an economic downturn, also introduced extreme instability in the global economy, so many banks increased mortgage rates to account for the additional risk.
This is a good example of how an unexpected event can ruin even the best predictions of the future, which is explained by the Black Swan Theory…
The Black Swan Theory (the massive impact of rare events)
Created by Nassim Nicholas Taleb, a Lebanese-American mathematician and philosopher, the Black Swan Theory describes the extreme impact of unpredictable events. The original metaphor is about the long-term assumption that “all swans are white”, leading to the ancient Latin expression of a “Black Swan”, being something that didn’t exist. This was proven wrong by a single observation of the existence of black swans in Western Australia in the late 1600’s. In a single moment, an entire system of thought was turned upside down.
“Black Swan Events” like September 11, the Global Financial Crisis, and COVID-19 are similarly unprecedented, unpredictable, and cause massive social and financial disruption. You can read more about the theory on wikipedia, but the important takeaway is that these events happen, and there’s really no way that we can predict them. So, when making decisions based on whether mortgage rates will go up or down, be careful not to be too confident.
Your impact on mortgage rates
Of course, market rates are only one part of calculating the mortgage rate that you can personally receive from a lender. A much more significant impact comes from your personal circumstances. Factors including (but not limited to) your credit score, down payment, income, and existing debt repayments can all make a difference to the rate that you’ll eventually be offered.
So, will mortgage rates go up or down?
The only sure-fire way to know if rates will go up or down is to wait and see. Prediction is a fool’s game in many ways, even when we’re not exposed to the risk of Black Swan events (which we always are). However, whether rates are currently going up or down at a particular moment in time can sometimes be predicted based on a few indicators:
- If the economy is improving, interest rates should go up
- If the economy is failing, interest rates may go down
- A large economic downturn can mean very low rates, as the Bank of Canada tries to stimulate the economy
- Mortgage providers don’t always cut mortgage rates along with the Bank of Canada. Instability in the market can mean they need to decrease their risk exposure by increasing their margins
- Your personal circumstances will affect your mortgage rates more than anything
- Black Swan events can throw all of our predictions out the window
Speaking to an expert
A good understanding of how interest rates are set and what factors can increase or decrease them is a good start to understanding the current interest rate environment. However, whether mortgage rates will go up or down is still an extremely difficult question to answer.
If you’re trying to answer this question in preparation for getting a mortgage, it’s probably a good idea to speak to a mortgage broker. Mortgage broker’s are experts in mortgage rates and providers, and can advise you on the best course of action for your individual situation. Consultations with mortgage brokers are also typically free, which is a big plus.
by Tim Bennett