We’re less than a week away from a highly anticipated overnight rate announcement from the Bank of Canada. Does this mean interest rates are about to drop? If so, how much and are more coming? More importantly, how will this impact real estate markets?
We’ve looked at what’s likely to happen and come up with our analysis on the likely impact. Let’s review how we got here and what’s coming next week.
Ah, the spring of 2020…let the good times roll!
On March 27, 2020, the Bank of Canada dropped the overnight rate by half a percent to 0.25% and kept it at this record low level for almost two years. As the overnight rate directly influences lenders’ prime rates, we saw very low interest rates being offered on variable loans and lines of credit, including variable-rate mortgages.
It was a very good time to borrow money and lots of people took advantage of the low rates making the payments on mortgages affordable – well, payable.
Then came the spring of 2022.
After almost two years of these low, low rates, the Bank of Canada began to raise the overnight rate on March 2, 2022. We saw ten increases in the overnight rate from March, 2022 to July, 2023 and since July 12, 2023, the overnight rate has been steady at 5.00%. Canada’s prime rate went to 7.20% and remains at that level.
Anyone who had signed up for a variable rate mortgage in that two-year period of very low rates (basically spring of 2020 to spring of 2022) experienced their rates rising at a very rapid pace. The affordability of their mortgage payment went away for many homeowners and at the same time lots of potential home buyers saw their ability to afford a mortgage disappear. The result was a tremendous slow down in the number of sales and considerable fluctuations in the average price for real estate in Toronto and the GTA.
Welcome to the summer of 2024!
After almost a year of no change to the overnight rate (and therefore prime rate), it seems likely that we are about to start seeing some change!
Just a little bit over 75% of economists (22 of 29) are predicting that the Bank of Canada will cut its key interest rate by 25 basis points to 4.75% on June 5, 2024. Financial markets have already priced in slightly more than a 60% chance of that, so most of the smart people in the finance industry think change is coming.
Is this the start of interest rates dropping back to their old levels?
The short answer to that is no. It seems very unlikely that we will return to anywhere near the record-low interest rates we saw back in early 2020. The COVID pandemic made central banks in many countries take unprecedented action to stimulate the economy and Canada was certainly no exception.
While we won’t hit that sub 1% level this year (or perhaps ever again), the overwhelming majority of economists expect at least three rate cuts this year. If June sees the first of these cuts, that leaves two out of four more overnight rate announcement dates where we could see further price drops. After June 5, 2024, the rest of the dates are as follows.
- Wednesday, July 24
- Wednesday, September 4
- Wednesday, October 23
- Wednesday, December 11
There is some disagreement amongst economists as to where we will end the year, but the median forecast for an end-2024 rate is 4.00%, with the dissenting economists (about half) saying 4.25%. This means that from our current (as of today, May 31, 2024) overnight rate of 5% will drop somewhere between .75% to 1% over the course of the year.
How much of an impact does a 0.25% interest rate cut actually have?
In order to answer this question, we need to look at it from two perspectives.
The first is the actual dollar impact. With a current typical variable rate of 5.9%, the monthly payment for every $100K of mortgage is about $633. If the Bank of Canada drops their overnight rate to 4.75% and lenders drop prime accordingly, then we would see that variable rate drop to 5.65%. That lower prime rate results in a monthly payment of about $619 for ever $100K of mortgage. Yup, about $14 cheaper.
If you had an $800K mortgage, that would mean that your monthly mortgage payment of $5,064 would drop by $112 to $4,952 per month. An improvement, but nothing that will cause you to open bottles of champagne to celebrate!
If the actual dollar impact isn’t much, the other aspect to consider is how it impacts people from a perspective stance. With prime at 7.2% for the past year and no indication of it lowering, people began to consider this the new normal. Any homeowners who found their mortgage payments no longer affordable came to the conclusion that things weren’t improving anytime soon and sold, sometimes at a loss. Prospective buyers who were waiting on lowering mortgage rates to make a home affordable decided that home ownership might not be in the cards for them.
From this perspective, the impact of a lowered interest rate – with more to come over the course of the year – is much more meaningful than the actual dollar impact. Home owners with variable rate mortgage who have held on to their properties will see some small relief in their payments and will feel better about keeping the home longer. Buyers who could have afforded to purchase over the last year but who were nervous about where rates were going may now feel confident about moving forward with a purchase.
Will the end of the year be a whole different ball game?
Will the forecasted end of year overnight rate of between 4.25% to 4% have a huge impact on people in terms of dollars? If we take the most optimistic scenario where the overnight rate goes from it’s current 5% to 4% by the end of the year, we see some more significant dollar impacts, but not really anything that will change the market as a whole.
Our current $633 per $100K of mortgage would drop down to $575 per month if we see prime drop by 1% by the end of 2024. That’s $58 per month and works out to a savings of about $464 per month if you had an $800K mortgage. While any drop in monthly payments is useful, going from a mortgage payment of $5,064 to a mortgage payment of $4,600 isn’t exactly a sea change.
While predicting markets is a difficult thing to do, we’re confident that what’s coming will have a small impact on real estate sales and prices.
We are predicting that these forecasted rate drops will encourage some home owners to keep their properties longer, which means a slight drop in the number of homes hitting the market. At the same time, we think that buyers who were already able to afford the payment (or who were on the cusp of affording it) will move forward into making a purchase. It should mean an increase in the number of sales in the latter half of this year, but not to a significant extent.
If you’re thinking about buying or selling this year, depending on how things go with interest rates, then we’d love to help you navigate the changing landscape. Get in touch with us to have a discussion about the best approach!
