When money is free, it’s hard not to borrow it, even if the lender keeps warning you to be vigilant against debt. That’s exactly what Bank of Canada Governor Mark Carney has been telling Canadians while at the same time keeping their cost of borrowing as low as it’s ever been.
The obvious question of course is, if caution is warranted in borrowing, why is the cost of money so cheap? Since no one wants to pay more for their loans, particularly mortgage-holders, it’s a question no one bothers to ask Governor Carney.
But ask you should. Because the Bank of Canada’s free-money policy may lead you to places you’d rather not go.
A financial bubble is built on an unsustainable premise. Tomorrow’s bubble in the Canadian housing market is constructed on the premise that today’s record low mortgage rates will remain in place. And that, in turn, is based on the idea that inflation will continue to dissipate in the face of a slack economy.
Neither premise should be in your financial plan.
Today’s inflation rate is no more sustainable than today’s interest rates. Both are rear-view mirrors on where the economy has been, not where it is going.
Energy prices, which were falling a year ago, are now back on the rise. Just as the inflationary impact of those prices triggered the fatal rise in interest rates which, in turn, gave us the deepest postwar global recession ever, energy prices will once again push inflation and interest rates much higher. (See my post Financial Crisis or Energy Shock? for more on this.)
And this time the inflationary fallout won’t just be in the energy component of the Consumer Price Index. The impact will be much broader, as soaring transport prices encourage higher-cost local production to replace sourcing from cheap labor markets halfway around the world.
Stress test your floating-rate mortgage three or four percentage points from today’s level and take a good, long look at the resulting increase in your monthly mortgage payment. For some homeowners, that could be as much as another $1000 per month.
Twenty years ago a similar shock to borrowing rates caused Canadian housing prices to fall by an unprecedented 25 per cent. I know because I called it.
That call was as much about where interest rates were going as it was about where housing prices were heading. Based on current borrowing rates, today’s homeowners will be facing almost as large an increase as they did back then.
So heed Governor Carney’s caution when you decide how big a mortgage you can really afford to carry.
Because once the Bank of Canada starts raising your mortgage rate, it will be a very long time before they stop.