The rate of interest for a mortgage in Canada recently fell below the rate of inflation. This rarely happens, and the last time real mortgage rates were this negative was over 40 years ago. That was in the middle of an inflation crisis, where everyone bought property to hedge. It produced a bubble, which violently popped shortly after. Though that was then, and this is now. Let’s look at these wildly inefficient market numbers.

Real mortgage interest is the rate of interest paid, minus the annual rate of inflation. Mortgage debt with a 2% interest rate in an environment where inflation is 2% is a real rate of 0%. If inflation holds steady the lender is giving you money, returned with no real profit. They can buy the exact same amount of goods when they’re paid as they can before they lent the money. It’s essentially a free loan. Generous people, eh?

It doesn’t happen very often, but it’s happening right now in Canada.

Canadian mortgage debt is being lent out at less than the current rate of inflation. Generally, the most popular type of mortgage is the 5-year fixed rate term. The posted 5-year fixed rate was 4.79% in June, working out to 1.7% after inflation. That’s still a positive number, and would be a big profit margin. Healthy and booming market, right? Just one problem — no one pays the posted mortgage rate.  

Most analysis is done on the posted 5-year fixed rate, which is often used to set policy. Lenders rarely charge that rate, and its primary use is to calculate penalties. The best available rate is typically 220 to 250 bps lower than the posted rate. A 5-year fixed rate actually looks more like the prime lending rate, often a few points lower. So let’s look at the prime lending rate now to get a better perspective.

The prime lending rate for mortgages is much lower than the posted rate. It was 2.45% in June, which is 234 bps lower than the posted 5-year fixed rate. When adjusted for inflation, the real rate is -0.6% for June. A small improvement over the -1.2% seen in May, but still — it’s a negative number. A fairly big one when we’re talking about billions of dollars as well. They’re lending for cheaper than the current rate of inflation.

Low interest rates have pushed more conventional mortgage dollar volumes to variable rates. Long-term variable rate data isn’t available, but 1-year fixed rate data is pretty close. It is just 5 bps apart from the 3-year variable term, so they’ll give us a pretty close view.

Conventional mortgages with a 1-year fixed rate of interest came in at 2.79% this past June. After adjusting for inflation, the rate is -0.3% in real terms. Short-term mortgages in Canada have never been this low.

With all that said, you are probably wondering if that means you should borrow as much as you can right now. If you’re renewing your mortgage, ask your mortgage broker — it might be like you just won the lottery. If you’re buying property, the answer isn’t so clear.

In normal circumstances, the assumption is inflation will be stable over time. That’s not what central banks are saying. In fact, they are outright saying inflation will not be this high. A negative real rate today may not be one next year. In this case, the lenders are likely banking on a drop in inflation. This would allow them to support lending lower than the current rate.

The term length is also something else to consider. In the US, with the world’s most liquid currency, mortgage rates can be guaranteed for the life of the mortgage. No surprises if inflation gets out of control, and the state needs to stop suppressing rates. You already agreed for 30 years what you’ll pay. 

In Canada, you’re paying a hefty premium for anything longer than 5 years. That leaves most playing rate roulette on the balance of their mortgage on renewal. Defaulting isn’t so much of a concern since these borrowers will be stress tested. However, appreciation of the home is likely to slow (or correct) in the event of higher rates.

What does this tell us? It shows evidence of the housing market’s massive inefficiency, right down to financing. The real rate of interest is below zero, as if they needed to stimulate more borrowing. This is during a multi-decade high for credit growth, while home sales are just under the record high, and prices are growing at the fastest rate in history.

If you are looking to refinance or purchase a home over the next few months, contact us today at 877-296-2696 or email us at