Mortgage Turnover Threatens the Economy: Former Deputy Governor Warns of High Interest Rates and Overpriced Homes

Mortgage turnover threatens the economy, according to a former deputy governor of the Bank of Canada, who says interest rates are too high to justify current home prices.

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“The danger facing the economy is that many people took out five-year mortgages in the time of COVID, at rates as low as 1.5%. When they have to renew, their mortgage payments will jump, since current rates are more around 6.7%,” says Paul Beaudry, former deputy governor of the Bank of Canada.

Over the past four years and on 36 occasions, Mr. Beaudry decided, in concert with the five other members of his committee, whether the Bank of Canada’s interest rate should go up, down or remain unchanged. A heavy decision, which each time impacts millions of people who have mortgages and other debts. And what he sees in the future is not reassuring.

“Almost everyone in Canada has a mortgage of up to five years. So by 2025-2026, everyone is basically going to be renewing. If long-term interest rates stay at current levels, everyone is going to be hit,” he says.

Among mortgage holders in the country, only those with a variable rate and a variable payment (which increases with each increase in the Bank of Canada’s key rate) have so far been hit, he explains. But this group only represents about 8% of mortgage holders.

“But it’s going to continue to rise and hit more people year after year, because even those with fixed rates are going to have to renew soon,” he said.

House prices must fall

If long-term interest rates continue to be this high, inevitably house prices will have to fall, adds the professor in the Department of Economics at UBC at the University of British Columbia.

“I tell people, prepare yourself for risk. If bond rates remain high as they are at the moment, it will create an adjustment in house prices. Maybe not a market crash, but be prepared for an adjustment,” he says.

The logic is this: when the time comes to make a long-term investment (five years or ten years), people evaluate different choices: buying stocks or bonds for example, or buying a house. However, with bond rates currently hovering around 5%, it is becoming more and more profitable to invest your money elsewhere than in a house, and to rent instead.

“When you’re wondering if you want to buy a house, you should look at interest rates for five years and even up to 20 years, because it’s a long-term investment. If house prices remain very high and interest rates remain high, it’s not worth buying a house. If I have an investment to make, I will put my money elsewhere, in bonds or the stock market for example, and I will rent instead of owning,” he explains.

Outside the control of the Bank

The Bank of Canada does not control long-term bond rates, he points out. Rather, it is global factors, such as China’s appetite for Western assets or global demand for savings, that push rates up or down.

“I don’t have a crystal ball to know if long-term rates will continue to rise or fall, that’s the $10 million question. But many forces suggest they will remain high. At that time, there would be a significant adjustment in house prices,” he emphasizes.