By Kyle Carruthers
Borrowing money just got more expensive.
Last week the Bank of Canada raised its benchmark interest rate by 0.25 per cent and the big banks quickly followed suit boosting their own prime and mortgage rates.
Those who are locked in with their current rates (most homeowners) are safe for the time being and won’t feel the hit until renewal time. And even then, we need to bear in mind that in many cases, this latest rate increase just returns rates to where they were when many negotiated.
The effect will be felt immediately for those with variable rate mortgages, and secured lines of credit which typically come with interest rates tied to prime.
A quarter point won’t be devastating. But it will make a difference in our highly leveraged society.
The average price of a detached house in Whitehorse in the first quarter of 2017 sat at $423,300. At those prices, new buyers would need a minimum down payment of $21,165. After tacking on a $16,085.40 CMHC premium our new homeowner is left owing $418,220.40 on their mortgage. At that level, each quarter point in interest is going to cost about a $1,045 more per year.
To put that amount into context we can compare it against the estimated cost of a highly contentious policy that is in the news a lot these days — the planned national carbon tax backstop.
The anti-tax doomsayers at the Canadian Taxpayers Federation pegged the yearly cost of carbon pricing at $2,569. A more sober and thorough analysis, offered in Macleans Magazine by Trevor Toombe — an assistant professor of economics at the University of Calgary (who happens to be a member of the Yukon’s financial advisory panel) — pegged the average household cost for Canadians at about $1,100 and that is before any rebates or offsetting tax reductions.
So the latest rate hike — which is likely the first of several — was as big a hit to your average homeowner as the carbon tax will be once fully implemented in 2022. What’s more, it is doubtful that the banks will be providing a rebate of any portion of that revenue.
So rising interest rates are a big deal.
A generation of Canadians have now come of age at a time when interest rates only went in one direction — down.
Older adults often tell us of their first mortgages back in the 1970s and 80s with rates in the double digits. Yet despite these tales many millennials seem to have a tendency to treat low rates as if this is the way it always has been and always will be.
This isn’t to let older adults off the hook. Many got caught up in the fun and took out the equity they have gained by rising housing prices to engage in some consequence-free consumerism.
Interest rates have been so low for so long and debt so ubiquitous in our society that policy makers now have to tread very lightly. Policymakers have for some time been discussing rate hikes in order to cool overheated housing markets in Canada’s biggest cities, reign in consumer borrowing and respond to positive economic data.
Where will we go from here? Take my prognosticating on this subject with a grain of salt. I’ve been predicting increased interest rates that never materialized for years.
When I bought my first house in 2009, I was convinced that I needed to lock in the excellent rates being offered after the precipitous decline that had occurred in the wake of the 2008 U.S. financial crisis. I was reasonably confident that rates would soon return to normal. Four years later we refinanced a full point lower and recently refinanced again with a lower rate still.
These missed predictions notwithstanding, I now expect we will see only modest increases in rates in the medium term. We are just in too deep at this point. Increased debt loads mean that the economic recoil from rate hikes would be more severe than ever.
If a quarter point costs our average Whitehorse homeowner $1,045, a full point costs $4,182 and two points $8,364. That’s a lot extra dough for households to come up with. Even a return of interest rates to where they were at towards the end of the 2000s would have a devastating effect on families which would ripple through the wider economy. If we do return to the old normal it will occur at a glacial pace.
The nightmare scenario in this new normal would be the return of inflation to the broader economy. It is an elementary rule of economics that interest rates must exceed the rate of inflation. Otherwise there is no incentive to lend as returns are negated by the decreased value of each dollar. If inflation were to rear its head even the Bank of Canada would be powerless to stem rising rates.
We haven’t seen inflation of any significance in some time but there are a number of candidates for the catalyst that causes its return. Food production — which makes up a big part of the global economy — is facing greater natural pressures as a result of population growth and (potentially) climate change. Hints of protectionist winds emanating from the White House and in the European Union could increase the cost of goods.
A return to some semblance of normalcy for interest rates is long past due. I would count the decision of policymakers to leave interest rates so low for so long as way of trying to kickstart our anemic economies to be one of the greatest policy blunders of the new millennium. And it is a blunder we haven’t yet paid the price for.
But if interest rates keep rising, pay the price we will. And it will be painful.
Kyle Carruthers is a born-and-raised Yukoner who lives and practises law in Whitehorse.