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Where do Canada's mortgage rates go from here?

They can’t go lower, can they? And what if mortgage rates start to climb? Could that be the last straw for the housing market?

It’s tough to make a pan-Canadian call on where real estate will land in 2013. The Prairie provinces seemed posed to avoid the downturn, but sales are starting to fall in many markets with a price dip happening already or predicted to be on the horizon.

All this is happening with five-year fixed closed mortgage rates below 3%, even at some of the big banks. The 10-year mortgage, still not popular with Canadians, is down to 3.64%.

It’s not a stretch to think the rate on both of those terms will climb two percentage points. And what of the prime lending rate? It’s still 3% but tied to the Bank of Canada, which has been threatening to raise rates for months.

Rates could also go lower but one problem might be an antagonistic finance minister in Jim Flaherty who keeps warning the banks not to get into a so-called “mortgage war” by lowering rates.

This month Manulife Bank buckled under pressure from the Department of Finance and raised its 2.89% five-year fixed rate closed mortgage back up to 3.09% because of government concern.

“We think rates have to get to more normal levels,” said Craig Wright, chief economist with the Royal Bank of Canada, which said in a February report that one of the reasons home ownership has remained affordable is those low rates.

The bank’s affordability index shows the proportion of pre-tax household income required to service the cost of a mortgage, property taxes and utilities. On a two-storey home, it reached 47.8% in the fourth quarter of last year, but that was down 0.3 percentage points from a quarter earlier.

Mr. Wright said as rates have dropped, consumers have been moving into five-year mortgages at a faster pace and that will likely continue if the fear is they are going to rise. That’s a generally positive development because it means only a portion of five-year mortgages come due every year, so any interest rate shock is slowly worked into the market.

The real battle remains for first-time buyers. They already face tougher rules on eligibility for mortgages. They can only amortize over 25 years if they have mortgage default insurance, something required with less than a 20% downpayment.

That shorter amortization means higher monthly mortgage payments and ultimately qualifying for a smaller loan. A spike in interest rates would just push the first-time buyer further out of the market.

“Across Canada in many parts housing is still affordable,” said Mr. Wright. “A couple of markets, those that were looking stretched — Toronto and Vancouver — are starting to correct, and that’s not a bad news story as long as it’s a cooling and not a collapsing.”

Phil Soper, the chief executive of Royal LePage Residential Services, says he does see a decline in prices coming in the third quarter of 2013 but for the most part interest rates are offering some protection.

“It’s very difficult to conceive of a sharp downturn in this market when mortgage rates are so low,” said Mr. Soper. “There is absolutely no sociological change in people’s desires to own homes, young people want to be part of the 70% of Canadians who own homes.”

The price decline he predicts is a national number, meaning some local markets will probably need those low mortgage rates as they try to recover from a steeper downturn.

“With interest rates the way they are today, much of the correction in the Vancouver market will have worked its way through,” said Mr. Soper. “When people see a small opportunity, they leap in, particularly with mortgage rates where they are now.”

Martin Reid, president of Home Capital Group Inc., said while rates remain low, new guidelines from the office of superintendent of financial institutions have had a bigger impact. Among the key changes has been a restriction on home equity lines of credit being no more than 65% of the value of a home.

“There has been some scrambling to restructure products,” said Mr. Reid. “[OFSI] didn’t want 80% HELOCs that were really only loans [where you paid the interest].”

In some ways, the consumer has grown accustomed to low rates because housing has been slowing spite of the discounts.

“It was already slowing down [before the mortgage] rule changes,” said Mr. Reid. “The low rates help but employment has helped too. It may not be stellar but it is holding people in. People are working, people are still buying their homes, making their payments. Debt levels have been increasing so that risk is elevated but they are able to service that debt.”

His company isn’t forecasting rates to go up but even if they do, the increases are expected to be modest and occur gradually.

“A rapid rise in rates might be the concern,” said Mr. Reid. “That concern is off the table for now.”

Kelvin Mangaroo, president of ratesupermarket.ca, laughs when he thinks about rates going down even more.

“Over the past year, we’ve kept saying it can’t go any lower, it can’t go any lower,” he said. “Sometimes you break a certain barrier.”

The latest mortgage rate outlet panel he conducted with some experts in the industry came to the conclusion that fixed rates are got going to be moving very much in the near future.

“I think what that means is it offsets what we have seen with house sales going down,” said Mr. Mangaroo. “People still think they can afford their houses because interest rates are at an all-time low.”

He cautions that people really need to plan for a rainy day when rates will go up and that means having enough money to cover a mortgage based on that higher payment.

“We are already seeing some declines [in sales and prices] in some markets,” said Mr. Mangaroo.

What would happen if interest rates were actually to go up? He has no doubt.

“I think it would be the nail in the coffin,” said Mr. Mangaroo, adding he doesn’t see any rate hikes coming this year. “The Bank of Canada doesn’t want to do anything that would hinder the economy right now.”

Source: Garry Marr, Financial Post