On June 5, 2024, the Bank of Canada (BoC) became the first central bank in the G7 to cut interest rates—marking a major policy reversal since the pandemic. By voting to trim borrowing costs by 25 basis points to 4.75%, central bank officials set the stage for additional rate cuts this year as inflation continues to moderate.
The BoC’s actions have direct implications for investors, who’ve had to adjust their strategies in recent years due to rising interest rates. In anticipation of rate cuts for the remainder of 2024, this article provides private mortgage investors with actionable insights and strategies to adjust their investments and maintain high returns. The article will cover the implications of rate cuts on mortgage investments, strategies for adjusting investment portfolios, risk management techniques, and expert guidance on capitalizing on the changing economic landscape.
Understanding the 2024 Rate Cuts
The BoC’s first interest rate cut in four years was widely anticipated after Canada’s Consumer Price Index (CPI) hit a three-year low in April. The CPI increased at an annual rate of 2.7%, down from March’s 2.9% and well below the mid-2022 peak of 8.1%. The BoC maintains an inflation control range of 1% to 3%, with 2% considered the most appropriate target for price stability.
The BoC expects inflation to fall below 2.5% in the second half of 2024, setting the stage for additional rate cuts this year. Economists polled by Reuters anticipate two more quarter-point reductions in 2024, with the next cut potentially coming as soon as the BoC’s July meeting. Beyond July, the central bank will announce its policy decision on interest rates in September, October, and December.
Impact of Rate Cuts on the Mortgage Market
The BoC’s benchmark interest rate directly and indirectly influences borrowing costs across the economy. In the context of the Canadian market, the most immediate impact will be felt across variable-rate mortgages and home equity lines of credit. According to research by Royal LePage, 3.4 million Canadian homeowners will have to renew their mortgage by mid-2025, most at significantly higher interest rates than the ones they obtained before or during the pandemic. Meanwhile, Canada’s largest bank, RBC, revealed that nearly three-quarters of its mortgage portfolio is coming up for renewal in the next three years.
Rate adjustments can significantly influence bank lending, making traditional mortgages more competitive. However, a lower-rate environment doesn’t necessarily undercut demand for private mortgages.
Regardless of the prevailing policy environment, private lenders can charge higher interest rates and fees than banks due to the risk profile and structure of private loans. Private lenders offer more flexible lending terms, no government-mandated stress tests, and a quicker application process. For borrowers, a private mortgage is often worth the extra costs because of its inherent flexibility and ability to provide short-term financing.
Whether it’s helping borrowers access home equity or obtain custom mortgage terms, private lenders are expected to see greater activity over the next two years as demand for refinancing grows. In this context, declining interest rates could prompt more borrowing activity in general, which could create new opportunities for private lenders to capture more market share in the first and second mortgage markets. After all, private lenders significantly increased their market share when interest rates were at record lows. By 2023, private mortgages accounted for 8% of new mortgage financing, up from 5.3% in 2021, and 10%-12% of the overall mortgage market, according to the Canada Mortgage and Housing Corporation.
Adjusting Investment Portfolios
With the Bank of Canada navigating policy changes, private mortgage investing is expected to remain a highly lucrative investment opportunity. As interest rates decline, whole private mortgage investment programs could offer more attractive returns compared to traditional fixed income investments, such as government bonds and Guaranteed Investment Certificates (GICs).
In a changing rate environment, private mortgages offer broader diversification benefits, such as reduced correlation with public markets, variety in income streams, and a unique risk-return profile. Private mortgages can also be diversified by borrower type, mortgage type and security position, property type, loan duration, geography, and loan-to-value ratios. Well-managed private mortgage investment portfolios offer opportunities that match the unique risk profile of individual investors.
A changing policy environment is also an opportune time for investors to rebalance their private mortgage investment portfolio by adjusting asset allocations to maintain their desired risk-return profile. By working with a professional mortgage investment provider, investors can establish regular review periods for their investments and set an appropriate threshold for rebalancing.
Risk Management Techniques
Managing interest rate risk is crucial for private mortgage investors to maintain profitability and mitigate potential losses. Private mortgage lenders manage interest rate risk through active portfolio management, mortgage diversification, and duration management. They also employ in-house compliance teams to manage credit risk, market volatility, and potential regulatory changes. Private lenders manage credit risk through tight underwriting guidelines and carefully evaluating each borrower’s credit, income, and employment history.
Although market volatility impacts every major asset class, private mortgages have the added benefit of being non-correlated with public securities markets. Factors such as economic data, a shifting business cycle, and changes in monetary policy have a lesser impact on private mortgage investments. However, private lenders remain vigilant of the impacts of market volatility, particularly as it relates to the value of the underlying real estate security. They do this by employing geographic diversification, internal stress testing, and constant monitoring of economic and regulatory developments.
Capitalizing on Opportunities
Interest rate cuts can create new opportunities for private mortgage investors by increasing demand for alternative lending. Although interest rates on traditional mortgages are expected to decline, traditional lenders will maintain tighter lending criteria. That means rate cuts could increase demand for private mortgages among borrowers who do not qualify for traditional loans. Private lenders also stand to benefit from higher refinancing activity and increased demand for the acquisition of foreclosed or distressed properties.
Leveraging technology and data analytics can significantly enhance investment decisions in private mortgage investments by providing deeper insights, improving efficiency, and reducing risks. Technology and quantitative methods enable private lenders to monitor investments in real time, as well as measure and monitor a borrower’s credit risk over time.
Staying informed about market trends and regulatory changes enables private lenders to maintain a proactive approach to managing risks, ensuring compliance and maintaining a competitive advantage.
Expert Advice and Best Practices
Central bank rate cuts can significantly impact private mortgage investments by influencing borrowing costs, property values, and overall market dynamics. That’s why navigating rate cuts requires a proactive approach to monitoring central bank decision-making and its impact on the market.
According to James Laird, co-CEO of Ratehub.ca, the BoC’s rate cuts are significant because it means “we are now into a declining rate environment.” However, he cautioned against expecting significant changes in the near term because many borrowers are still priced out of the market.
“If you were nowhere close to qualifying for a home, you’re not going to qualify still” after the latest BoC cut, Laird explained.
Other experts say the BoC’s pivot on interest rates will be good for the economy, which could create a more positive return environment for certain types of riskier assets.
“What the rate cuts will mean for an economic outlook is much more positive,” said John Aiken, an analyst at Jefferies. “Given the Canadian banks are a beta play on the Canadian economy, anything that helps the Canadian economy will be beneficial to their bottom line.”
Morningstar reached a similar conclusion but warned that the impact of rate cuts depends on the underlying health of the economy.
“When interest rates are low, borrowing costs decrease, stimulating economic activity and potentially benefiting corporate earnings. Companies also pay less interest on their debts,” Morningstar analysts wrote. “The pre-conditions for interest rate cuts often (but not always) involve a recession – with cuts often occurring in periods of significant economic weakness. If a recession occurs, [risk assets] can struggle.”
According to Shannon Terrel, a personal finance expert at NerdWallet, investors with exposure to traditional fixed-income securities should review their portfolio allocations following the BoC’s rate cut. In her view, the higher rates on GICs and savings accounts in recent years could begin to reverse should the BoC follow through with multiple rate cuts.
In the current market environment, six of the largest domestic pension plans, such as BCIMC and CPPIB, are expanding their lending in private credit. According to CMI president Kevin Fettig, investing in private mortgage lending offers a way for individual investors to adopt this investment strategy.
“In a declining interest rate environment, private mortgage lending provides an attractive opportunity for investors seeking competitive returns,” said Fettig. “By following the lead of major pension plans, individual investors can benefit from the security and yield potential that private credit offers. This strategy not only diversifies their portfolios but also positions them to capitalize on favourable market conditions.”
Conclusion
Adjusting investment strategies in response to interest rate cuts is essential for optimizing returns, managing risks, and taking advantage of new opportunities. By working with a trusted private mortgage investment partner, private mortgage investors can maintain high rates of return in the face of shifting central bank priorities.
CMI Financial Group is one of Canada’s fastest-growing non-bank financial service providers, with nearly $3 billion in successful mortgage placements. Contact us today for a free consultation to learn more about CMI’s private mortgage investment opportunities.
