Are the days of ultra low mortgage rates gone for good? On August 20, the Bank of Montreal raised its benchmark five-year mortgage rate to 3.79 per cent. The Royal Bank quickly followed suit the day after, raising its posted five-year rate to 3.89 percent. Most other major lenders have since raised their rates as well. What is going on? Is the rock-bottom mortgage rate party over already? To address these concerns, let’s turn to the economic experts for some answers. “I think this is the real thing.” said one bank economist. “Affordability in the third quarter is probably going to deteriorate.” said another chief bank economist.
All of this expert commentary sounded confident and authoritative, but was it useful? I say no. The problem: Mortgage rates had already gone up. It’s easy to speculate as to why something happened when it has already happened. It’s much harder (and much more useful) to predict something before it happens. Unfortunately, when you look at the track record of interest rate forecasts, the accuracy of the socalled experts is a little short of abysmal. I think Warren Buffett neatly summed up forecasting using his Noah principle; “Predicting rain doesn’t count, building arks does.” In other words, hind sight is 20/20. To be fair, forecasting things like interest rates, unemployment levels and currency exchange rates with any sort of accuracy is virtually impossible.
The interaction of millions of people, behaving in sometimes irrational ways, makes market prediction a crap shoot at best. Many economic variables follow an almost random-like pattern. So in a world of randomness, is planning for the future futile? Planning is still an extremely important part of achieving your life goals, even in a random world. The key is to focus on the things you can control, and have contingencies for life’s surprises. For example, we can’t predict what future rates will be, but we can add a margin of error to our plans. Using a standard mortgage rate calculator available on most bank websites, we can calculate that a 1% increase in the current five year mortgage rate will increase a mortgage payment by approximately $138 a month on a $250,000 mortgage. Adding a margin of error to your mortgage plans will give you some wiggle room if rates do in fact rise further. Luckily, we do have control over many important levers in our financial lives. For most of us, the saving and spending decisions we make will have the biggest impact on our financial future.
That is something to remember if you have the urge to jump into the real estate market right now. Unexpected rises in interest rates like the one in August are usually followed by a jump in real estate activity, as buyers flock to the market to avoid any further increases in borrowing costs. However, it’s worth noting that the savings from getting a low rate mortgage are often more than offset by the cost of overpaying for a home (sometimes the result of a bidding war). Life will always be unpredictable, but it’s important to focus on the issues you can control. This will better prepare you for life’s inevitable storms and floods. It will also help you navigate to the calm waters that eventually follow.
Paul Carvalho, MA, CFA is President, Chief Economist and Wealth Advisor with Reeves Private Wealth. He has spent 15 years in finance with a global custodian bank, a major investment firm and a Canadian Chartered Bank.