How the Iran Conflict can affect your Your Mortgage
Why should Ontario mortgage holders care about conflict happening thousands of miles away in Iran? As odd as it may seem, the effects of the Iran conflict might be one of the reasons why mortgage rates rise.
When conflict breaks out in a major oil-producing region like Iran, crude oil prices tend to spike almost immediately. Why is this important? Because higher oil prices can lead to higher inflation. We’ll discuss why rising inflation can affect mortgage rates later in this article.
For the moment, let’s discuss why conflict can affect oil prices.
Conflict and Oil Prices
Oil prices don’t just reflect what’s happening right now — they also reflect what traders think is going to happen. So if Iran, a major oil producer, gets caught up in a conflict, traders don’t necessarily wait to see whether oil actually stops flowing. They ask themselves simply: “How likely is this conflict to disrupt the supply of oil?”
That anticipation alone can push oil prices higher because traders are reacting to the risk of a disruption, not just an actual disruption. Traders start buying oil now because they believe that if supply does decline later, oil prices could be even higher. That buying pressure alone can drive up the price of oil today.
Rising Oil Prices Affect Mortgage Rates
To understand this relationship, you first need to understand what can cause a bank to raise its mortgage rates. There are many factors that go into a bank’s rate decisions, but two of the most common are related to:
A. Investors selling bonds, which causes bond yields to rise
B. The Bank of Canada raising its key interest rate
We’ll discuss each of these separately, but an important concept to understand is that both can be influenced by the same thing: inflation.
Point A: Why Bond Investors Fear Inflation
Oil isn’t just what goes into your gas tank. It’s a key input in shipping, plastics, fertilizer and countless manufactured goods. So when oil becomes more expensive, those higher costs can ripple through the economy, pushing up the prices of other goods and services — and that can increase inflation.
Bond investors fear inflation because a bond pays a fixed return. If inflation rises, it eats away at the purchasing power of that return. If your bond pays you the same $100 a year from now, but prices have gone up, that $100 no longer buys you as much as it would today.
If bond investors expect inflation to erode their returns, they may sell their existing bonds and move their money into investments that offer them a higher return. When investors sell bonds, bond prices fall and bond yields rise. Rising bond yields are one of the reasons banks may raise their mortgage rates.
Point B: The Bank of Canada
If the Bank of Canada thinks inflation is going to remain too high, it may consider increasing its key interest rate. When the key rate — also called the overnight rate — rises, it can cause banks to increase the interest rates they charge their customers.
Inflation can potentially do two things at the same time: motivate the Bank of Canada to raise its key interest rate and cause bond yields to rise.
Why Banks Raise Mortgage Rates
Banks pay customers interest to deposit money with them. Banks also charge interest to customers who want to borrow money. The basic business model is: a bank needs to charge borrowers more money than what it pays to savers who give the bank money.
Banks also fund mortgages by raising money in the bond market. If bond yields increase, the bank’s cost of funding those mortgages can increase. The bank may then pass some or all of that additional cost on to borrowers by raising mortgage rates.
When the Bank of Canada increases its key interest rate, it also increases short-term borrowing costs. As regualr banks sometimes borrow from the Bank of Canada, it can become more expensive for them and they may increase mortgage rates to protect their profit margins.
Put It All Together
- Oil prices spike, pushing up the cost of manufactured goods and services across the economy.
This raises fears that inflation will increase. - Bond investors fear that inflation will erode their returns, so they sell bonds, pushing bond prices down and bond yields up.
- The Bank of Canada may raise its key interest rate to fight inflation by slowing borrowing and consumer spending.
- As bond yields rise and the Bank of Canada raises its key interest rate, banks may respond by raising mortgage rates to protect their profitability.
A conflict on the other side of the world, and suddenly your future mortgage rate can look very different.
So What?
Where does this discussion take us? For starters, it would help if we could predict where mortgage rates are headed. If we understand where inflation is going, we can get a better idea of what might happen to bond yields and future Bank of Canada rate decisions.
How to Predict Mortgage Rate Movements
There’s no single number you can look at that tells you where inflation, bond yields and ultimately mortgage rates are headed next. Bond yields and the Bank of Canada respond to a mix of economic signals, and lonlyooking at only one of these data points in isolation can be misleading.
Complementary indicators can help. It’s like predicting the weather — one gust of wind doesn’t tell you a storm is coming, but wind, dropping pressure and darkening skies together start to paint a picture.
For anyone with a mortgage renewal on the horizon — or someone getting a new mortgage to purchase a home — that’s the real value of watching these indicators. You’re not trying to predict the exact mortgage rate you’ll get. You’re trying to access enough information to make an educated prediction about whether mortgage rates are more likely to rise or fall.
If you’re about to renew your mortgage, you’re probably asking yourself two questions.
One: Should I renew early or wait until the natural end of my mortgage term?
Two: When I renew, should I choose a fixed rate or a variable rate?
Renew Early or Wait?
If you prefer fixed rates and you think mortgage rates are going to rise, then you may want to consider renewing your mortgage early. This strategy allows you to lock in a rate today instead of waiting until the natural end of your mortgage term, when rates could potentially be higher.
If you prefer variable rates, you may decide to wait until your renewal date so you can see where rates actually go. A rising-rate environment can have a negative impact on your cash flow with a variable-rate mortgage.
Fixed or Variable?
The decision between a fixed and variable mortgage depends on much of the same data. If you think bond yields are going to fall and the Bank of Canada is going to cut rates, then a variable mortgage might be the better strategy.
Conclusion
The Iran conflict may be thousands of miles away, but its economic impact can eventually affect your mortgage payment. Understanding how oil prices, inflation, bond yields and Bank of Canada decisions are connected can help. One can make better decisions about when to renew and whether to choose a fixed or variable mortgage.
You may not be able to predict exactly where mortgage rates are going, but understanding what is driving them can help you make a more informed decision about what to do next.
Extra Reading
If you are interested in researching some of the economic data discussed in this article, here are some sources:
