The Bank of Canada’s decision on Wednesday to follow the U.S. and cut its key lending rate is a clear sign households will see lower borrowing costs ahead, but that’s not good news for the many millions of Canadians who are actually lenders ― even if they don’t think of themselves as such.
Within hours of the Bank of Canada’s announcement Wednesday that it’s dropping its lending rate half a percentage point to to 1.25 per cent, most of Canada’s major banks followed suit, dropping their prime rates by the same amount.
That’s an instant boost to Canadians with variable-rate mortgages, as they will now be paying less in interest costs.
Watch: All the ways Canadians and Americans are now totally different, financially. Story continues below.
According to mortgage comparison site Ratehub, someone who bought a home for the average price in Canada (roughly $500,000) with 10 per cent down will save $115 a month on interest, or $1,380 a year.
The same is true for people with home equity lines of credit (HELOCs), which are also tied to banks’ prime rates.
And for new borrowers, it will mean an easier mortgage stress test. Ratehub estimates that, with the new lower prime rates and an expected tweak to the rules in April, the rate needed to qualify under the stress test will ease to 4.59 per cent, from its current 5.19 per cent.
Bad news for retirees
But for retired Canadians, these rate cuts could eat into savings and income.
“Unfortunately, Canadians can expect these lower rates to be passed along to their high interest savings accounts, GICs and other fixed income investments,” said James Laird, Ratehub co-founder and president of Canwise Financial, in a statement.
“Retirees who rely on fixed income investments should expect their monthly cash flow to decrease.”
Another way of looking at it is that it’s good for younger Canadians, who tend to borrow more than they save, and bad for older Canadians, who save more than they borrow.
Typically, when Canadians retire, their savings are converted low-risk investments designed to generate a stable monthly income ― mainly cash and government and corporate bonds. So while retirees don’t think of themselves as lenders, that is in fact what they tend to be.
And the interest earned on those bonds tends to rise and fall with central banks’ lending rates ― which is why critics of low interest rates say they reward borrowers while punishing savers.
Lowest mortgage rates ever?
Even with the interest rate cuts in the U.S. and Canada this week, prices in the bond markets are signalling more rate cuts ahead. Bond markets in the U.S. are signalling that they expect the Federal Reserve’s overnight lending rate to drop to below 0.5 per cent by the end of the year, from its current target of 1 to 1.25 per cent.
If that happens, the BoC is likely to drop its key lending rate in lock step. (Leaving Canadian rates higher than U.S. ones would cause the loonie to soar, and the BoC doesn’t want that ― bad for exports.)
This week, the interest paid on two-year U.S. government bonds hit an all-time low of below 1 per cent. U.S. mortgage rates quickly followed, with 30-year mortgages hitting their lowest ever rate at 3.89 per cent.
The same could soon be headed for Canada. Interest on five-year Government of Canada bonds has dropped in half over just the past month ― to around 0.7 per cent, from 1.4 per cent. If this trend continues for just a few more business days, those rates will be the lowest ever.
That means borrowers of the most popular kind of mortgage in Canada ― the five-year fixed-rate ― could soon see the lowest mortgage rates this country has ever seen.
Unfortunately, the downside would be that retired Canadians will see the worst returns on fixed-income investments they have ever seen. The one upshot for the Golden Years crowd might be that, with lower mortgage rates, they can expect the value of their homes to keep soaring.