Recent changes may be good news for homebuyers

We’ve had back-to-back changes recently in the mortgage world – one direct, one indirect. The benchmark rate used to qualify will change downwards starting April 6, 2020, and the Bank of Canada (BoC) just cut its key lending rate from 1.75% to 1.25%.

Two years ago, the stress test was introduced as a safeguard against rising interest rates, to make sure homebuyers would still be able to make their mortgage payments if their rate increased. To qualify for a mortgage, buyers need to qualify at the greater of 2% higher than the contract rate or the Bank of Canada’s average 5-year rate, which today is 5.19%.

Earlier this month, Minister of Finance, Bill Morneau, announced changes to the benchmark rate used to determine the qualifying rate for insured mortgages – mortgages with less than 20% down payment. This change will come into effect on April 6, 2020.

There has been mixed response from the financial community about this change. For some, the new qualifying rate will make it more affordable; for others, it won’t make much of a difference, especially in hot-market areas, where prices are rising quickly.

Then, on Wednesday, March 4, 2020, the BoC cut its key lending rate by 50 basis points, from 1.75% to 1.25%, which had an almost immediate effect on lines of credit and variable-rate mortgages -- banks dropped their prime rate from 3.95% to 3.45%.

This means that borrowing costs for mortgages, auto loans and other lines of credit are set to head lower. Consider a $400,000 mortgage on a 2.95% variable rate. The mortgage rate would shift to 2.45%, and mean about $100 per month in savings.

Why is this happening?

The interest rate drop comes on the heels of the US Federal Reserve’s decision to lower its rate by .50 points due to the global economic challenge posed by the uncertainty of the coronavirus that will likely affect domestic spending. The BoC’s rate cut of the same percentage took many by surprise – it was expected that rate would drop a quarter of a percentage.

There were also other yellow alerts prior to the coronavirus – a drop in global equity markets and in oil prices, created uncertainty in the financial markets. It wasn’t a stretch to think that the same drop in confidence would hit consumers as well. The BoC does not want to jeopardize domestic growth.

With regard to the stress test, there has been pushback from some economists and housing experts who say that the new stress test will just further fuel the housing market.

Here’s what we know about the stress test

• Currently, the stress test for insured mortgages is 5.19% (the minimum rate at which homebuyers must qualify, no matter the actual contract rate.)
• The new stress test, if it was in place today, would be approximately 4.89%.
• The Big Banks will no longer determine the stress test rate. This is good news. Banks have been hesitant to cut their-five-year posted rates (which the stress test is based on). This has made it more challenging for borrowers to qualify for a mortgage.
• Borrower’s will have slightly more purchasing power

Here’s what we don’t know

• How it will affect the average buyer. This will depend on a variety of factors, including the location of the property being purchased. In smaller markets, the new benchmark could help affordability for some buyers – in larger markets such as Vancouver or Toronto, it may have little effect.
• If it will affect home prices. More consumers qualifying for a mortgage may increase demand and put upward pressure on prices – there is still a shortage of properties available for sale.
• The new benchmark calculation, as stated, is more flexible. If interest rates continue to fall, then, in many cases, buying power would also increase.

As always, time will tell how all this will play out and there is talk that the BoC will cut the rate at least once more this year.

What does this mean for fixed versus variable-rate mortgages?

Fixed rates are priced on the bond market, which have fallen quite dramatically since January, so it’s likely that fixed rates will continue to move lower.  Now, with the BoC rate cut, and the banks following suit by dropping their prime rate, variable-rate mortgages will also drop.

Many factors go into deciding whether to choose a fixed or variable mortgage, and it’s a topic to discuss with your mortgage professional.

For now, these changes could be good news for homebuyers.

Canada set to grow in different ways

The Canadian economy is poised to grow again, but in a very different way according to the Bank of Canada’s (BoC) recently-released Monetary Policy Report.  The BoC expects global economic growth to strengthen…. gradually… and modestly.

Once again, the U.S. market is impacting growth in Canada. While there is demand for our exports, US residential investment and investment in their oil and gas sector, which are key sources of demand for Canadian exports, has changed.  Economic activity there expanded at a modest pace at the end of 2015 and the beginning of 2016, and while it was hoped that there would be strong momentum, it hasn’t happened.  Growth is expected to remain modest for the year.  Not surprising given it’s an election year.

The Loonie
The battered loonie has been showing signs of life. It recently hit 79.50 cents US at one point during the last week in April -- its highest mark since July 2015.

Global economies
Unfortunately, economic recovery in the euro area and Japan continue to yo-yo. Low oil prices and exchange rate depreciations have dampened growth.  In the euro area, growth is also being restrained by ongoing deleveraging, weak investor confidence and tight lending conditions. In Japan, lackluster wage growth is restraining consumption.

China
The economy there is in transition with movement away from industry and more towards the service sector, which now accounts for just over 50% of China’s GDP.  China’s GDP growth is expected to slow from 6.9% in 2015 to 6.3% in 2018. Fiscal stimulus is expected to be focused on additional infrastructure spending and tax relief for businesses

Canadian Economy 
The inflation rate is projected to stay below 2% through 2016. Core inflation is expected to be around 2% through 2017. The economy is also in transition, moving toward non-resource sectors.  This adjustment is expected to contribute to the moderate growth cycle we are now in for the next two years.
 However, it’s not all bad news.  Economic activity through 2016 and 2017 has been revised up, thanks to measures introduced in the federal budget in March.  The gap between growth and activity is likely to close sometime in the second half of 2017. This adjustment period is expected to last until 2019.

The Housing Market
New construction and activity in the resale market is strong in British Columbia and Ontario, relative stability in Quebec and the Maritime provinces,  although there are declines in housing activity in  oil-producing provinces. The strength in British Columbia and Ontario appears, in part, to reflect local demand stimulated by employment growth. The shift in interprovincial migration in response to the oil price shock is reinforcing the regional divergence in housing market activity as workers leave the oil-producing provinces for Ontario and British Columbia.

The strength of housing demand in Ontario and British Columbia is contributing strongly to growth in residential mortgage credit.

The BoC continues to keep its overnight rate at .05%. Stephen Poloz, President of the BoC, defends his monetary policy and said, “The fact is that policy actions -- monetary and fiscal -- taken in the wake of the global financial crisis, prevented what would have been a second Great Depression. But many of the negative forces that were acting then are still acting now. That’s why ultra-low interest rates are not causing rapid growth and inflation.”

There will be lots to watch in the upcoming year as the world transitions. What that will look like is anyone’s guess.

This is a recession in the 21st century

The past few weeks we’ve seen the dollar sink, the Bank of Canada’s rate drop to .50%, and not-so-great economic reports over the last two quarters have been released.  And with all this comes discussion that Canada is going through a…(whisper) recession.

According to the definition of a recession -- a period of temporary economic decline during which trade and industrial activity are reduced, generally identified by a fall in GDP in two successive quarters – that’s what we’re experiencing. However, this seems to be a very different downturn than previous recessions.  And because the definition puts us squarely in one, it doesn’t mean that the country is slipping into serious economic trouble.

David Madini of Capital Economic said, “The recession may not last much beyond the middle of this year (2015).

Here’s some of the key data.  According to Stats Canada figures, the Canadian monthly trade data are now back to pre-2008 levels. However trade data and deficits are simply movements in capital and may not be the best indicators of the economic health of a nation. The U.S has been in a trade deficit for four decades without much harm – in fact, they seem to have prospered well through it all.

While economists fret about trade data and GDP numbers, consumers just keep buying, despite the struggling loonie.  They’re buying cars.  The housing market is still humming along in most parts of the county. Canada’s imports are higher this year, which is benefitting consumers.  Employment is strong in most parts of the country. And consumer confidence is high.

This may be the best recession ever. Or perhaps this is what a recession looks and feels like in the 21st century. Some economists are now suggesting that, although by definition, Canada is in a recession, the two-quarters rule may not be the best test.

During the recession in the early 1980s Canada experienced higher inflation, higher interest rates and high unemployment.  The Bank of Canada rate hit 21% in August 1981, and the inflation rate averaged more than 12%.

Canadian companies no longer focused on innovation and productivity improvements – they were in survival mode.  Also, high inflation was partly responsible for larger government spending. In the early 1980s, Canada’s unemployment rate peaked at 12%. It took almost four years for the number of full-time jobs to be restored.  Real GDP declined by 5% between June 1981 and December 1982. By 1979, the Canadian dollar was worth 85 cents U.S., which made U.S. imports more expensive. On the other hand, Canada’s major exports declined in price. Combined with high inflation, and interest rates, these high commodity prices reduced the standard of living.

Pretty grim picture. Now fast forward to today’s recession. The inflation rate remains in check at 1%. Canada’s unemployment rate is approx 6.8%, which is considered normal. The Bank of Canada rate is .50%. There is an entire generation of Canadian who have never experienced high interest rates -- today’s low rates are the norm for them. 

After the June employment figures were released, Scotiabank released a report suggesting the country was not in a recession “in any meaningful or broadly defined way.”

Some have billed it the Great Canadian Non-Recession.

Technically, we may in a recession and those in areas impacted by the downturn in the oil industry may be feeling it the most, however, consumers are purchasing big ticket items and home sales were up 3.1% from April to May.

So what’s going on?  Is this a true recession? Or, is this what we can expect future recessions to look like going forward? Perhaps the definition of a recession needs to be updated. The world has certainly changed in the past three decades. Some of the credit has to go to government policies. Policymakers have lived though previous recessions and have put safeguards in place to ensure old scenarios are not repeated.

But more so it might be that just two quarters data numbers is not enough anymore. Douglas Porter, chief economist for BMO Financial Group, says it’s too early to declare a recession – that there are some other indicators such as the three “Ds” – depth, duration and dispersion -- which have not been met yet.

Whatever Canada is going through at this time, it has not had a negative impact on most households… and really, that’s all that matters.

How will the recent rate cuts impact mortgage regulations

By Mark Kerzner, President, TMG The Mortgage Group

With the latest Bank of Canada (BoC) rate cut to 0.50% comes a reminder that many would like us to believe our housing market is tenuous.  Once again there is a lot of discussion about just how overheated our market is and the dire circumstances many current homebuyers are likely to find themselves at renewal time.

First, let’s think about why the Bank of Canada decided to cut interest rates once again last week. In January the BoC surprised many of us and cut the overnight rate in response to a rapid decline in oil prices.  This time around it did so because the Canadian economy has not rebounded the way the Bank had hoped.

In an effort to stimulate spending, the Bank used one of its levers to lower the cost of borrowing. In doing so the value of the loonie further decreased thereby making imports more expensive and exports cheaper. The hope is that foreigners will both invest in and buy Canadian goods.  The caveat to that appears to be Canadian real estate where many economists and policy makers would prefer that no additional investment takes place. The problem is, it’s hard to have it both ways.

The Canadian housing market is resilient – no doubt about that. But when we speak of the Canadian real estate market we really have to speak in terms of what is happening in Toronto and Vancouver and then the rest of Canada … the latter is nowhere near as hot as the former.

For the past seven-(ish) years the Bank of Canada, the Government of Canada, our mortgage Insurers and our lenders have introduced numerous lending restrictions designed to strengthen the underlying housing market, soften a blow at the time of renewal  --in the event of increased mortgage rates -- and reduce the rate of home price appreciation.  In the wake of these last two rate cuts, discussions are heating up again.

Now we are hearing rumours of increased down payment requirements as well as possibly reducing the maximum amortization. Both of these changes could have a significant impact on the market – and I do not believe the policy makers are looking for ‘significant’ market changes immediately preceeding an election. They could, however, prove to be precursors to a discussion to take place later this Fall.

In late 2008 the Bank of Canada reduced the overnight rate and the banks passed along only 3/4 of the reduction. So far in 2015 the banks have passed along only 30 of the 50 basis points.

While the banks do incur costs with each change to the overnight rate they are also ‘banking’ additional spread on both new and on their existing books of business. With arrears remaining at very low historical rates, and the high quality of borrowers, the banks are already protecting themselves from a potential overheating of the housing market. As such, to potentially trigger a downturn in the Canadian housing market by pushing regulations too far, such as increasing the down payment requirement to 10%, would not be prudent.

In the event the down payment requirements were to increase to 10% approximately 20% of first-time homebuyers could be affected. Some will find the means to borrow additional down payments and others may seek out secondary financing. At the margin, for the homebuyers that remain in the market, their cost of borrowing will increase.

Another “buy”-product of lower interest rates are lower bond yields. People look for better returns on their investments and some will move funds into equities.  Perhaps this will prove to be a good long-term investment strategy, though in the long run, real estate investing may turn out to be a sounder investment approach.

The reality is, in the wake of a massive global recession (2008-2009), followed by major geo-political uncertainty and a perilous Eurozone, our economy, and especially our housing market, have done phenomenally well. The steps taken over the past 6-plus years have proven prudent.

Once again we find ourselves in a sort of conundrum – borrowing costs are getting cheaper, the economy is stagnating yet our housing market, at least in two major cities, continues to push forward.  My concern is that we overshoot and impact one of the main engines -- first-time homebuyers -- that drives the marketplace.

I think it’s important to ensure that families who invest in real estate have the strength and ability to do so. I do not believe that policy makers should be trying to massage the actual market itself. As such, here are a few recommendations they may wish to consider.

• Register all first-time homebuyer mortgages at 30 or 35-year amortizations but set qualifications as well as payments at 25 years.  In the event of a future default, payments could then be set at 35 year amortizations to allow for some flexibility and preservation of cash flow.

• Keep the down payment minimum at 5%, though in certain geographic locations require liquid assets equal to 7.5% (plus closing costs).

• Index the cut off where mortgage insurance can be obtained. For instance a number of years ago a policy was created that restricts mortgage insurance on properties that were greater than $1M. That number should be indexed to allow for natural price appreciation (or depreciation) and geographic factors in the market.

 The housing and mortgage markets in Canada have proven to be resilient. Now more than at any point in our young history, it is vital for Canadians to seek the expert advice of mortgage brokers to navigate their options.

No panic necessary over interest rate increases

(Blogger's note: To everyone's surprise, the BoC lowered the interest rate on Tuesday, January 21 to .75%. The impact if that is yet to be seen and will be addressed in another blog. This blog addresses the two types of interest rates and what consumers should understand about them.)

Interest rates have once again become a hot topic in the media. Just prior to oil prices nose diving, the Bank of Canada (BoC) hinted that the overnight rate would likely start rising in 2015. Of course, the media had a heyday with headlines of how rising rates will affect affordability for homeowners and talk of “bubbles” started to emerge…again. (See Blogger's note above)

It’s important to understand which interest rate the media is discussing because there are two very different types of rate – fixed and variable – and both rates are determined by very different criteria.

The rate making most of the headlines is the prime rate. The prime interest rate, which the Bank of Canada (BoC) controls, is what determines variable interest rates.  The focus of the BoC is on stimulating the economy and keeping inflation in check. The best way to stimulate the economy is to get people to spend money, so keeping interest rates low is beneficial.  Until oil prices starting tumbling, the economy was recovering and starting to grow and the BoC started talking about raising rates.

The BoC rate is currently at .75% -- this is the borrowing rate for lenders. The Bank’s prime interest rate is 3%. Variable rate mortgages are based on the BoC rate. When rates do rise, it is usually in small increments and over time will start to add to the amount consumers pay for credit facilities like lines of credit, overdrafts and variable-rate mortgages. In today’s mortgage market, five-year variable-rate mortgages are available in the prime minus 0.50% to prime minus 0.70% range.  Even with potential incremental rises in the prime rate, these discounted rates, are still attractive.

There are many factors that contribute to rising interest rates. Since the economy was in recovery, it only made sense the BoC would start raising the rate. But lower oil prices may have put a hold on that decision. The BoC has already expressed concern about the impact of sharply lower oil prices on the economy, and is likely to be more cautious about when to start increasing rates. As we have seen, the BoC lowered the rate.

Fixed rates, on the other hand, are at historic lows and it looks as if they will stay low for awhile. Fixed rates are based on bond markets, independent of what’s happening with the prime rate. The Bond market, like all markets, fluctuates daily. Lower oil prices and market volatility is exerting downward pressure on bond yields and fixed mortgage rates. Today, five-year fixed mortgage rates are as low at 2.79% to 2.99%

Here’s a closer look at bond markets:

* Bond yields are set like many other prices - by the forces of competition between supply and demand
• If there are more investors wanting to buy bonds, as is often the case when they sell equities, bond yields tend to drop
• Financial Institutions use the spread between interest charged to borrowers and paid to investors to cover their costs and generate some profit

With all the insecurity in the market today, investors are buying bonds and yields continue to drop and are now below 1.10%.

So does this mean fixed rates will drop? Some experts think so. However, John Bordignon, EVP for Paradigm Quest doesn’t think so. “While I believe fixed rates will remain stable, there is still volatility in the market and lenders are still cautious about lowering the fixed rates,” he said.

Bordignon doesn’t rule out the occasional promotional fixed rate discount, but because the costs of mortgages have gone up, lenders are not likely to tighten the spreads.

The choice of opting for a fixed rate versus a variable rate is ultimately a personal decision. Each situation is unique and its best to discuss the options with a mortgage professional. But when the headlines are screaming doom and gloom for interest rates, make sure to understand what type of interest rate they’re referring to.

Good news for interest rates

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

There’s good news on the interest rate front. In the Bank of Canada’s (BoC) most recent announcement it maintained its prime rate at 1%, however with one slight difference. Since 2012, the BoC’s report has included a tightening bias, warning Canadians that rates would soon rise. That bias was removed from BoC Governor Stephen Poloz’s recent report. Instead he is planning to hold the overnight interest rate at these low levels at least into 2015. The reason? Low inflation and a slow economy.  Inflation is sitting just above 1% (the BoC likes it near 2%) and annual economic growth is limping along at 1.6%. 

In the late Spring, it looked as if the end of these ultra low rates was near. The US FED had signaled it was going to slow down its Quantitative Easing (QE) of reducing its massive $85 billion dollars/month injection into the markets. Bond yields spiked approximately 80 bps shortly thereafter. This spike in yields led to an increase in fixed interest rates and a collective exhale at the BoC. After all, increasing rates would help to slow down the perceived overheating of the housing market.

At the same time, many consumers sitting on the sidelines saw the wave of increased rates coming and they 'bought forward'. This means they were potential buyers, but acted more quickly than they otherwise might have, to take advantage of the ultra low interest rates.

Just as the mortgage industry started to get comfortable with the recent round of increased mortgage rates, bond yields started to taper off – 40 basis points in fact -- over the past few weeks. If yields continue to fall, or even if they stay stable for a period of time, there may be some reductions in fixed rates yet again. And while this is welcome news for many, it is concerning for officials in Ottawa.

Also, variable rates are near prime-0.50% and the trend is towards bigger discounting. Now that the BoC has said there won’t be an increase until 2015, variable-rate mortgages will likely become more popular.

Since the BoC has not been able to raise rates nor curb spending in the housing market – sales in many markets continue to grow and house prices continue to rise. One way the Government can control the housing market is by making changes to the mortgage guidelines, so we might get some rule changes again.

In a meeting with private sector economists, Finance Minister Flaherty said he was not intending to interfere with the housing market "at this time." That would imply that he is not going to make any changes just yet.  What we have learned over the past five years is that "just yet" certainly means "it may be coming sooner than you think."

If, and that’s a BIG IF, the government believes that home prices are continuing to escalate out of control, and the housing market is overheating, it may act. What is holding them in check right now seems to be the notion that the market has 'bought forward’.  This may have caused a positive blip in housing activity in recent months.

Over the next few weeks we will have to pay close attention to housing market activity in Canada to see if it is indeed tapering, and also have to watch the impact if fixed interest rates do drop. In this respect, lower rates may not be such a great thing because we could be facing a fifth round of changes.  The talk on the street is if there are changes coming, it might be capping amortizations on conventional loans to 25 years, similar to high ratio loans.
We will wait and see.