Wednesday, June 26, 2013

Reviewing the relationship of interest rates and bond yields

By Mark Kerzner, President, TMG The Mortgage Group Canada Inc.

It has been said in the past that when the US sneezes Canada is very likely to catch a cold. That reference shows just how intertwined the Canadian economy is with the US. For a number of years since the start of the great recession Canada has lauded itself for its performance in the wake of extreme economic weakness in its G8 counterparts, including the US. At this time however, we seem ready to be bracing for that head cold again.

Economists are starting to forecast an economic rebound in the US beginning later this year and in to 2014.  Unemployment rates continue to drop, housing prices are starting to rebound and given what we have all learned regarding the "wealth effect" we know that when consumers feel richer they start spending. The overall economy looks like it is growing with GDP forecasts in the US now above 3%. Given this US economic optimism the FED has signalled it is going to stop purchasing $85+ billion a month in US Treasuries and Mortgage Securities (some of you may have seen this referenced as Quantitative Easing (QE)).  Note: they have not said they are stopping the capital injection, just that at some point in the future they are going to. This has the markets concerned about inflation along with economic optimism are driving yields higher.
Here is a quick refresher with respect to bond yields

  • Bond yields are set like many other prices - by the forces of competition between supply and demand. One relationship to note is that as prices go up, yields go down (and vice versa).
  • If there are more investors wanting to deposit their savings for 5 years (purchasing 5 year bonds) the 5-year bond yields will tend to drop
  •  Bond yields will tend to increase if investors expect inflation to increase or an economy to be strong.  This happens because investors want to ensure their funds do not lose purchasing power over time
  • On average, the 5-year bond rate has declined over the past 15 years.
The bond market is a good gauge for the establishment of mortgage pricing. Most financial institutions, regardless if they are selling in the MBS, CMB, etc will still use the spread between bond yields and mortgage rates as a means of establishing pricing. The historical correlation between the bond and fixed mortgage rates is over 90%.
And while we know there is a very strong connection between bond yields and mortgage rates what has become increasingly unclear is the spread that financial institutions are expecting to make these days. So while we can usually determine the direction of rate movement, the magnitude of those movements are somewhat harder to predict.
On May 1st 5 year bond yields were 1.15% - 5 year rates were 2.89% to 2.94%
On May 17th they were 1.32% - rates remained fairly stable. There were a few quick close promotions that ended.
On June 6th they were 1.42% - rates had begun to creep up and were in the 2.94% to 3.04% range
On June 19th they were 1.55% - 5 year rates continued to creep up and were in the 3.04% to 3.19% range
Today they are sitting at approximately 1.85% and we are hearing of more impending rate increases - some as high as 3.39 to 3.49%.
Between May 1st and today bond yields have increased by approximately 70 basis points while pricing has only increased approximately 50 to 60 basis points. That means that either there are going to be further rate increases or lenders are prepared to earn smaller spreads during this Spring market.
Brokers and consumers alike have all enjoyed these historical low rates as well as a prolonged period of stability (of interest rates). Now with bond yields starting to spike what does this mean for rates and where will it all net out? That is the million dollar question. If you believe that the FED will hold true to its word and stop purchasing billions in Treasuries and Mortgage Securities, the US Housing market will continue to rebound, and global economies will strengthen thereby purchasing more exports than yields will keep climbing. If on the other hand you feel that we are still not out of the words with respect to a global economic crisis and thereby a prolonged US recovery we may see some relief from this latest upward yield pressure.
In the meantime, the "insurance" spread of taking a 10 year term has narrowed considerably and should be considered for some, especially where payment security is sought. On the other hand, the discount of ARM to 5 year fixed (the difference in rate between a discounted variable product against a 5 year fixed) has also grown, meaning for some who feel that although yields are rising, the Bank of Canada is likely to leave the overnight rate alone for some time to come, should consider a discounted ARM.
We are experiencing more market volatility than we have become used to in the last little while. If it continues, and I suspect it will, we will see more regular rate movements than we have in the past 6 months or so.

Monday, June 03, 2013

Save at renewal time by using a mortgage broker

Consumers are becoming much more informed about mortgages and mortgage products before taking the plunge into home ownership. According to the Canadian Mortgage and Housing Corporation’s (CMHC) 2013 Consumer Survey, 70% of buyers researched terms and conditions, 60% discussed the pros and cons of various mortgage products with professionals and 59% compared interest rates.

Because consumers are highly engaged, they are more confident about their mortgage decisions, according to the survey. Still, with all that research, more than half contacted a mortgage broker to get further clarification. This is a good move, considering how much the mortgage rules have changed over the past few years.
The survey also found 81% of buyers were totally satisfied with the experience with their brokers and would most likely use that broker again. An overwhelming 75% would highly recommend their broker to family and friends.
A study recently released by RBC Economics found that low mortgage rates have helped make owning a house largely affordable in the first quarter of 2013, with low risk that rates will move up sharply.  It’s likely that this low interest rate environment will go on for the next two years. 

The year 2008 was one of the biggest years for mortgage originations in Canada. That means a large percentage of those mortgages are now maturing. Discounted variable rates were popular and those discounts no longer exist, so those mortgage holders will be facing increased mortgage costs.  For most homeowners, their biggest monthly expense is a mortgage payment. Yet the CMHC survey found that 39% of households automatically renew their mortgages when the term is up instead of trying to find a better deal.

When you’ve done your homework prior to purchasing a home, it only makes sense to do as much research at renewal time. Quite often the renewal rate offered to you by your lender is higher than the market average.
There may also be material changes in your household. Perhaps you’ve started a family, or one of you has been promoted.  This is another good time to contact a mortgage broker to review your financial situation and see what makes sense for you to do.

Here are some tips to make sure you’re getting the best mortgage product for you:

  • Get going early. Contact your mortgage broker four to six months ahead of renewal time. Most lenders will guarantee a discounted rate for four months but your renewal agreement is usually sent only 30 days ahead of your maturity date.
  • Do your homework. Let your mortgage broker shop the rates for you and get you the best deal, tailored to your particular situation. If you decide to switch lenders, there are no penalties at renewal time.
  • It’s not always about interest rate. Don’t fixate on rate. There are other options that may appeal to you such as changes to amortizations or changes to the rate type. 
  • Let a broker negotiate on your behalf.  If you don’t like negotiating and don’t have the time to do the research, your mortgage broker will do the legwork for you. Homeowners who use a broker at renewal time usually pay less than those who don’t use one.