Stressing over the debt-to-income ratio? Don’t!

The debt-to-income ratio has hit the headlines again.  This time the ratio rose to 167.3 % in the fourth quarter of 2016 compared to 166.8% in the third quarter. That means for every dollar of disposable income, consumers owe $1.67.

This increase has been fuelled by mortgages and low-interest rates, which has some policy-makers getting antsy.  They’re concerned at what could happen if rates rise. Yet consumers have been able to pay their debt relatively easily. And low interest rates have allowed consumers to pay down more of their mortgage principal, with payments split almost evenly between interest and principal in the fourth quarter.

Benjamin Tal, Deputy Chief Economist for CIBC, isn’t having it and is calling an end to the debt-to-income ratio. In his weekly Market Insight he calls the ratio the most quoted number and the most useless economic indicator. The main reason is what the number is assessing versus what it doesn’t assess.

For example, it’s unlikely that consumers will pay off their mortgage in a year, yet the total debt amount is factored into the debt-to-income ratio.  Mortgage debt accounts for 65.5% of ratio.  The ratio also looks only at the debt of consumers who already have debt rather than the income of people with and without debt.  Perhaps not a totally accurate picture, then.

According to Tal, in a “normally functioning economy, debt will rise faster than income.”  The ratio is designed to rise and has only fallen twice in the past 25 years. 

Tal also pokes holes at the pace of increasing debt. Here are the numbers:

• Total real household debt is now rising by just over 4%, in line with the recovery of the 1990s
• Consumer credit is  rising by only 2.5%, slowest pace over the past 30 years (non-recessionary)
• Mortgage credit rising by 5.2%, which is low
• Household incomes rising at 2.5%, the long-term average
• Seems pretty normal.

TD Bank economist Diana Petramala wrote “Debt growth has accelerated somewhat, but it is not growing at the double-digit pace that would typically be considered dangerous.”

Equifax has reported that 46% of consumers were decreasing their debt.

So, Tal is pretty clear when talking about debt -- make sure to say something about what’s included in that debt. The simple catch-all number may be too simple for a complex story.

If you are carrying high interest debt and want to talk about opportunities to consolidate by refinancing, speak with a mortgage broker.

How Brexit will impact you

By Dan Pultr, Vice-President, British Columbia

(With files from Gina Monaco)

All news channels, and most of the world, have become obsessed with Brexit, for good reason. In what is a now a historic moment, the majority of voters in the United Kingdom voted to exit the European Union (EU) – a partnership that came into existence after the Second World War. It morphed into an economic and political union of 28 countries working as a single market, which allows free movement of goods, capital, services and people between member states.

The negative effects of this decision was immediate – markets dropped, currency values fell and trade relations have become shaky. The reason  -- uncertainty. No one knows the long term implications -- not the economists, not the leaders of the remaining countries, not even those who voted to leave.  And it may take years to find out.

What we do know, however, is with uncertainty comes changes and it could and most likely will impact Canada, specifically our housing market. Here are a few ways that Brexit may affect you:

Interest rates will remain low
The immediate impact of the post-Brexit vote on Canada's economy will be pressure to keep interest rates at historically low levels, according to BMO chief economist Douglas Porter. That's good news for consumers. The U.S. Fed, which seemed ready to hike rates in September, will likely delay that decision, for now. In Canada, economic conditions continue to support low interest rates and a delay by the US will almost certainly leave things unchanged. The Bank of Canada's latest rate announcement held the overnight rate at .05%, which is good news for variable rate mortgage and loan clients.

The Loonie
The Loonie fell fast after the vote, relative to the US dollar. In the end, it lost more than a full cent, closing at 76.93 cents US. However, on a positive note, relative to the Pound and Euro, the Canadian dollar has strengthened, as Europe grapples with the economic fall out, so if you're headed to the U.K. or Europe, chances are you'll be pleasantly surprised with the exchange rate.

Your savings
If some of your savings are in equities or mutual funds, the Brexit vote may have had a surprise negative impact on your portfolio. However, most economists don't believe another financial crisis is at hand. Historically, markets tend to overreact at first then start to reclaim some of their losses. Although Brexit is cause for concern and has created uncertainty, the long term impacts are still not known and many are saying the reaction is overstated and to hold on until the dust settles.

Foreign investment in our real estate
Canada is at a crossroads right now. On the one side, many real estate investors will be looking for alternative stable regions to invest in than the UK at the moment, and Canada may be the most attractive. That said, foreign investment in Canadian real estate has already been cause for concern in some key markets. In the short term, there will definitely be an increased demand for Canadian Real Estate from St. John’s to Victoria, to Vancouver and Toronto. The key development will be how foreign investment in real estate is handled by policy makers.

While Brexit has created uncertainty in a dramatic way, there is an upside. If you're searching for a new home, you’ll continue to enjoy record low interest rates and your home may be worth more than ever before. If you’re looking to refinance to pay off debt or lower your borrowing costs, increased property values and low interest rates help home owners unlock some of that equity they’ve built up as property values continue to rise and the most advantageous terms.

Negative interest rates and you

I have a great deal for you – give me $100 and I will give you back $99. No? Well, that would be the result of a negative interest rate scenario The Bank of Canada’s  (BoC) Stephen Poloz has alluded to as an option  in case of another global  economic crisis. We’re not there yet and it is unlikely we will ever get there, but if we did, it’s not likely consumers would be impacted in a big way.

So what would happen if we had sub-zero interest rates? First of all, that loan deal presented at the beginning of this article would be the scenario for the banks. When you put money into a deposit account, you earn money on that deposit. For example, if you deposited $100 and 0.5% interest rate, you end up with $100.50. A negative interest rate works the other way. If you deposited $100 at a negative 0.5% interest rate, you would end up with $99.50.

If banks were to keep borrowing from the BoC, they would be paying for the privilege of doing so. The idea is to force the banks to be more liquid. Instead of saving, they get a financial return by using more of their funds for loans.

It’s not a “normal” response to an economic crisis but a few countries have gone there recently – Denmark, Sweden and Switzerland, for example. The BoC has other tools and the new government is working on a stimulus package that will likely help get the country growing again.

Loans may cost less but loans wouldn’t necessarily be easier to get -- consumers would still have to qualify. And unlike in Denmark, where some banks are paying mortgage holders a small monthly interest on their home loans, that is not likely to happen here.  Also, if rates did go sub-negative, it likely wouldn’t mean added banking fees for saving-account customers either.  If that were to happen, consumers would just hoard their cash.

“The lower rates go, the more likely you are to spend,” said Carlton University economics professor and monetary policy expert Nicholas Rowe in an interview with Global News. And low interest rates stimulates the economy because, “it’s a big encouragement to go out and spend your money,” he added.

As for mortgages, the variable rate might be affected but fixed rates are depended on the bond market.  In fact discounts from prime on variable mortgages have actually decreased significantly in recent weeks. Encouraging home ownership is good for the economy overall because when people buy homes, they also buy other goods for that home.

There are two reasons to cut interest rates: to stimulate the economy through increased borrowing and consumption and to devalue the currency to boost exports.

There may be some good news on that front.  Many Canadian economists expect good news in the upcoming months.  Although it has taken longer than expected for the economy to depend less on the oil sector and more on the manufacturing sector, growth is expected in 2016 and 2017.

A lot is riding on the federal government’s new stimulus package, aimed at kick-starting a sluggish Canadian economy. Although the details have not yet been released, BMO Capital Markets thinks it will lead to economic growth. They crunched the numbers and say, at best, “stimulus would lift GDP growth by a bit more than 0.5% next year.”

If so, BMO’s call for just over 2% economic growth in 2016 and 2017 edges a bit higher to 2.5%.
Although it’s not likely we’ll see negative interest rates, it’s good to know there is a plan in place, just in case.

Consult a mortgage professional for sound mortgage planning

The housing market has dominated the headlines over the past years. Rumours of rate hikes have never materialized. The market didn’t crash. Prices continue to increase in large urban centres. Despite the most recent recession, Canada’s housing market soldiers on and is still at the core of media commentary and policy revisions.

Since 2011 we have seen changes come into effect to restrict mortgage lending in Canada, and those changes continue today – all in an effort to curb the market.

The housing market continues to be a vital component to the success of the Canadian economy as it has during the past decade. In many respects, the industry has helped to stabilize a faltering economy.  By allowing consumers an opportunity to purchase by taking advantage of low interest rates or to tap into their equity for either spending or investing purposes, the mortgage channel has contributed positively to consumer spending and confidence.

While debt-to-income levels are indeed at its highest point in Canadian history, over the past 20 years personal lines of credit have accounted almost exclusively for the surge in total consumer debt and consumer credit card debt has surged at higher levels than mortgage debt. However, consumers are managing their debt loads well.

Earlier this year, The Canadian Association of Mortgage Professionals (CAAMP) published a report titled A Profile of Home Buying in Canada.  The report offers information on homebuyers, and profiles some key aspects of their decision making process, as well as the financial parameters of their decisions. Here are the highlights:

•  Each year in Canada, about 620,000 households move into dwellings they have purchased
• Of those 620,000 approximately 45% (280,000) are first-time buyers -- most between the ages of 25 and 34.
• Single-detached homes (estimated at 360,000 per year, or 57% of the total) account for the largest share of home buying for all of Canada. 
• On average, the homebuyers made down payments of about $119,000, equal to one-third of the price of the homes. 
•  For first-time buyers, down payments averaged $67,000, equal to 21% of their average purchase price.
•  Buyers do relatively little shopping when they chose their real estate and mortgage professionals.
• Among the buyers who obtained financing, only 16% did not consult  a mortgage professional 
• Only 9% of borrowers say they did not shop for mortgage quotes  
•  56% of mortgage borrowers consulted mortgage brokers 
• Mortgage brokers are used most often by for first-time buyers 

The growth of the housing will remain neutral in the near term. The resale market activity is widely anticipated to remain close to current levels for the rest of the year and into 2016.  And low interest rates are with us for awhile.

Here’s the track record for the mortgage broker channel:

1.  On average,  consumers using a mortgage broker saved 19bps on their interest rates (Competition in the Canadian Mortgage Market, Bank of Canada Review, Winter 2010-2011, p.5) 
2.  Those who renewed or renegotiated recently with a mortgage professional reported an average rate decrease of 1.4 points, compared with 1.0 point among all renewers. (Maritz Research Canada, January 2011)
3. Since 1992 changes to the Bank Act, the Big 8 (Big 6 plus Desjardins and ATB) now own more than 80% of mortgage assets in Canada. In the wake of that reduction in competition, the mortgage brokerage channel has grown by over 300% (from 10% to 30%).  This competition IS in the best interest of consumers.

As a country, we are fortunate to have weathered the global recession and we have managed to grow through the most recent “technical” recession. Canada is operating on sound financial principals and our housing and mortgage markets will continue to remain robust. It’s been proven that mortgage professionals  get better deals for Canadians and it’s been proven that competition is vital to Canadians’ best interests.

Clearly, home buyers, other than new home buyers, would benefit from consulting with a mortgage professional.

Don’t get caught up in the headlines

By Dan Pultr
Vice-President, British Columbia, TMG The Mortgage Group

Despite what seems like a focus on statistics that creates fear in the media, Canadians are still making their mortgage payments, while enjoying the cheapest borrowing environment in history.

 Not that long ago, all headlines were focused on the household debt to income ratio, which has proven to be a poor indicator of the financial situation of Canadian households.  That ratio, actually, has decreased recently, but the “number” alone is the focus of headlines.   

More recently, attention has turned to foreign ownership – that this may be causing a housing bubble in certain parts of Canada. However, the data doesn’t support this hypothesis and even the most anecdotal analysis suggests that most of the sales activity by foreign buyers has been in high-end homes (north of $3M) in Vancouver and Toronto.

The reality is in Canada, there is nothing to fear.  Even if all of the headlines were true and the most concerning of assumptions became reality, Canada is not in any way in a similar situation to that of the U.S. pre-financial crisis.  Nor is Canada the same as it was eight years ago.

Let’s look at the facts. Canada is currently enjoying the lowest interest rate environment in history.  It has never been more attractive for homeowners to borrow money.  Five-year fixed rates are around 2.6% to 2.75% and 5-year variable rates are nearing 2%.  Notwithstanding these low rates, lenders focus on providing mortgages to only the most creditworthy applicants with provable income. 

Since the Global Financial Crisis in 2008, the lending landscape in Canada has drastically changed.  At one time we had  American sub-prime lenders operating here such as Accredited Home Lenders, Wells Fargo, and GE Money, to name a few.  However, capital requirements imposed by the Canadian government made it almost impossible for these small lenders to survive.

The mortgage business was also much more attractive to banks and investments banks and many prime lenders such as Macquarie, First Line, and ING have left the mortgage channel completely. We didn’t see new lenders for a long time, until recently. 

The Canada Mortgage and Housing Corporation (CMHC), The Office of the Superintendent of Financial Institutions (OSFI)and the Ministry of Finance have changed mortgage lending rules and have increased compliance requirements, which have eliminated most of the riskier lending such as the No Income Qualifier (NIQ). We also once had 40-year amortizations, 100% financing (including on rental properties), refinances to 95% of the value of a home, and stated income loans with very little documentation.

We’ve had five policy changes so far and the introduction of mortgage underwriting scrutiny via B-20 and B-21.  Ask a self-employed borrower trying to get a mortgage and he or she will tell you how more challenging it is today than it was 10 years ago.

 Yes, if you’re credit worthy and have provable income, you will enjoy the lowest rates ever. Often borrowers get annoyed in this new lending era, where the need for paperwork and more paperwork seems daunting. Lenders require more information, more paperwork, and more due diligence -- more everything.

Canada’s delinquency rate is at 0.28% -- its lowest rate since 2007 -- and close to the lowest rate in history.  That means that for every 10,000 mortgages, only 28 of them currently have missed three mortgage payments in a row.  In the U.S, the delinquency rate is 5.77%.  It’s comforting knowing that if the market should take a turn, the housing market would be fine.

So in reality, Canada is actually doing pretty well.  Our government has focused on ensuring the people who get mortgages can afford to pay them. Despite these changes, our mortgage and housing markets are still growing.   This is good news for the future of these markets. 

Make sure to speak with a mortgage broker so  they can help you navigate our current lending environment to ensure you get the best mortgage to meet your unique needs.

Housing slow down heralding a more balanced economy

For the past four years economists have been warning us of a slowdown in housing activity, of lowered house prices and of interest rate increases. None of which have come to pass, until now, with the exception of interest rate increases and clearly, no one really knows what will happen with rates.

“Real estate, it has nine lives,” said Benjamin Tal, deputy chief economist at CIBC in an interview with the Globe and Mail. “Every time it’s supposed to slow down because of interest rates, something bad happens elsewhere that keeps interest rates low…”

Here are the most recent predictions from the Canada Mortgage and Housing Agency (CMHC).

New-home construction will slow over the next two years as low oil prices continue to take their toll on the economy despite rock-bottom interest rates.  Prices of resale homes will rise 3.4% this year before slowing to 1.5%.

Oil-dependent provinces such as Alberta and Saskatchewan will be hit hardest.  Home prices will likely decrease below the national average in Alberta.

In the rest of Canada the slowdown will be due to the shifting preferences among buyers. Where once buyers set their sights on higher-priced, newly built detached homes, they will start looking at buying older entry-level resale homes and more affordable new builds, such as townhouses and condos.  A healthy supply of condos and townies has kept those prices more affordable.

In Canada’s two high-priced markets – Vancouver and Toronto, demand for detached homes may fall because they are just not as affordable. However, just outside of these two hubs, prices are affordable.

CMHC also predicts that mortgage rates will rise slightly over the next two years, with five-year posted rates set to range from 4% to 5.5% this year, rising to 4.2% to 6.2% next year – caveat: We’ll see.

Many economists also say that our housing market is overvalued. Some say upwards of 60% compared to rent, some say about 30%, but the consensus seems to be between 10% and 20%.  But we may be looking at the wrong comparison.  What’s really important is a mortgage holder’s ability to pay.  And that means people need to stay working. 

So far, job numbers are good. The unemployment rate is holding steady at 6.8 %. Compared to a year earlier, Canada has added 161,000 jobs (a gain of 0.9 per cent) and the total number of hours worked has grown by 1.2%. Full-time jobs have risen by 1.8% over the past year. 

However Canadians are carrying large debt loads. At last count in March the debt ratio was 163.6% -- a record high. However, in June the debt ratio declined. It appears that in a low interest rate environment, consumers pay down debt.   Benjamin Tal said in an interview, “We have seen in the past that Canadians use low interest rates to actually pay down debt faster, as opposed to add to their debt…”

It looks as if consumers don’t have a problem paying their debts…unless interest rates shoot up past “historical norms”.  Yet, how many years have to pass before something becomes history?  We’ve been living with low interest rates since 2008 – that’s seven years. It could be that low interest rates are now the “norm”.

We are living in times that are defying textbook scenarios on the economy. Clearly world economies have changed. It’s not likely that interest rates will skyrocket in the next few years, given what’s happening in the world; it is more likely they may start to increase… slightly. 

What we’re seeing today is the correction that economists predicted would happen two years ago. With it will come a more balanced, stable economy where people are happily working, who are able to pay their debts, where interest rates are “low normal” and  where house prices are affordable. 

In the end, economists will look back and say that everything unfolded as it should.

Did the mortgage market do what we thought it was going to do in 2014?

By Susan Ashton, BComm, AMP, TMG The Mortgage Group

As we all know, predictions and forecasts are all well and good but sometimes they fall short of what actually happens. While I might be able to predict, with some level of certainty, what is going to happen tomorrow, the longer the time frame, the harder it is to “hit the nail on the head”.

So let’s start with last December’s Globe and Mail article – Five Canadian Mortgage Market Predictions for 2014. I thought it would be fun and interesting to revisit this article and see how accurate it really was.

Keep in mind that Rob McLister of Canadian Mortgage Trends, the author of The Globe and Mail article, is one of the thought leaders when it comes to shooting straight from the hip about the mortgage industry and where’s it’s going. Here’s what he said would happen in 2014:

1. Prediction: New mortgage rules – Expect more rule tightening in 2014 designed to reduce mortgage risk for lenders, mortgage default insurers and the government. By definition, those rules will make it slightly harder to get approved for some mortgages and further slow the housing market.

What actually happened: Well, when it comes to new mortgage rules, we certainly saw lots of changes in 2012 and 2013, but fewer in 2014. We had CMHC cut their Self-Employed/Stated Income and Second Home products but there were no changes to the Genworth and Canada Guaranty (the two private insurers) products, so this hasn’t had a significant impact on approvals. We have seen lenders starting to change the way they view payments for debt servicing purposes on personal lines of credit. Where once we could use the actual interest–only payment, as long as it was proven, most lenders want us to use 3% of the outstanding balance. We still had a couple of lenders who would use the lower payment amount, but these last remaining lenders will discontinue this practice at the end of this year so I predict more restrictions in 2015 than we saw in 2014.

2. Prediction: Credit unions will steal market share – Since they’re provincially regulated, credit unions have more flexible lending guidelines than federally regulated banks. They’ll use that to their advantage in addition to marketing more heavily, both online and to mortgage brokers. We’ll also see some big mergers this year as credit unions seek out economies of scale.

What actually happened: Credit Unions are definitely increasing their market share. While I can’t say that I am using them more, they can do things that OSFI regulated lenders just can’t.  I expect it will take more time than one year to see Credit Unions really make a noticeable dent in market share.

3. Prediction: Stronger online player – A new online model is sacrificing commissions for volume. This trend will heat up competition industry wide, delivering greater mortgage discounts to all consumers.

What actually happened: Some online brokers do compete on rate though the full service brokerage model remains alive and well. Your mortgage is more than just rate – it’s about getting the best product for your situation; it’s about getting the right advice for your situation and it’s about protecting your future.

4. Prediction: Hybrid mortgages will grow more popular – Economists and government officials have been warning us of higher rates for four years. So far they’ve been wrong, and now many consumers aren’t sure what to believe. More Canadians will hedge their rate bets with hybrid mortgages (part fixed and part variable).

What actually happened:  Hybrid mortgages are definitely talked about more, but I’ve found that clients want the stability of a fixed rate payment, or the advantage of the lower payment/rate that a variable offers. Mainly it’s the savvy, yet risk adverse, investors who talk hybrid mortgages. These products represent a great opportunity to speak with your mortgage associate about what is right for you.

5. Prediction: Consumer IQs will increase – For those in the mortgage industry who prefer an uninformed consumer, your days are numbered. Canadians will spend more time researching rate comparison websites, online mortgage forums, news portals, blogs, calculators and other online mortgage tools. They’ll become increasingly savvy about fine print like penalty calculations, rate blend policies and refinance restrictions.

What actually happened: Consumer IQs are most certainly getting higher. The Internet has brought about change and transparency in the industry, which has benefited consumers. The younger generation also educates themselves online prior to making any sort of purchase – another great thing for the industry. I love to work with clients who come into my office, armed with great questions with a goal of learning even more. The perfect client! This will only continue as the amount of available information grows.

So there it is. Rob McLister just released his predictions for 2015 in the Globe and Mail. Let’s see how well he predicts the market next year.

Stay tuned!

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.

Rising interest rates and your mortgage

By Mark Kerzner
President, TMG The Mortgage Group

Over the past few years it seemed every expert was telling us that interest rates would be rising, but after years of record low fixed rates, I think many of us stopped believing the headlines. 

With bond prices dropping and yields on the rise, those rates (fixed-rate mortgages) that are tied to bond yields have shown dramatic movement over the past month. For the most qualified, the rates on 5-year fixed mortgages have increased from a low of 2.89% to 3.59%, and are potentially still rising.

The term, “jumping on the band-wagon” now comes to mind. We see it most often with professional sports teams, fads, and sometimes even with politicians. It seems we may be seeing it in the mortgage industry as well. In the past week, I’ve read a number of articles speaking to the virtues of variable-rate mortgages.


Are variable-rate products quickly becoming the better option?

Do you remember the days of 5-year adjusted rate mortgages (ARM) priced at PRIME – 75 or even PRIME – 90? If you were fortunate enough to have one of those products and stayed with it over the course of the term, you’ve come out a winner. Since the last PRIME – 75 funded approximately four to five years ago, those rates have become extinct and now those clients renewing their mortgages have a choice to make.

Should they renew into a current ARM product at PRIME – 40(ish)or take the security of a fixed-rate term in the fear that rates will continue to rise?

Economists are predicting the Bank of Canada will hold the overnight rate steady into 2014. That said, take these predictions with a grain of salt as many of those same economists had already called for increases back in 2012 and 2013. Economic conditions change and so do outlooks and forecasts.

When looking to determine if there will be interest rate shock it’s important for mortgage renewers to consider not just their current effective interest rate, which may be PRIME – 75 or 2.25%. Rather, focus on what the rates were at the time the mortgage was funded when PRIME was 4.75% (August 2008) to the current rate options. 

In many cases there will be no shock at all, especially if clients took advantage of hold-the-payment options while rates started to decrease. For example, the effective interest rate and payments set at the time of funding was 4% and current 5-yr. fixed mortgages can still be had at the 3.39 to 3.69% range.

Relatively speaking, variable-rate mortgages are cheaper today at PRIME (3%) – 40 than they were five years ago when they were at PRIME (4.75%) – 75.  The spread between fixed rates and variable rates is sometimes referred to as the “rate premium” or even “fixed rate insurance” and is a good evaluator of the attractiveness between fixed and variable.

This time, five years ago, that spread was approximately 150 basis points (5-yr. fixed rates averaged 5.50%). Today that spread is around 100 basis points. If that spread grows, variable-rate mortgages will again become more attractive compared to their fixed-rate counterparts.

Before making any final decisions keep in mind two last items. First, in late 2008 both fixed rates and PRIME were dropping. Today, PRIME is remaining flat for the time being while fixed rates are rising.  Second, credit and lending guidelines have changed significantly in the past five years.

Today’s borrowers are better qualified and have fewer opportunities to defer interest costs using extended amortization and lower down payment options.  Those who are willing to take the additional risks of variable products are better equipped to do so than those in the past even though the risk premium is effectively higher than it was five years ago. 

That said, our rate environment today compared to August 2008 is quite different since both variable and fixed rates do not seem to be dropping. To really understand the best option, it’s best to discuss these factors with a dedicated mortgage broker. He or she will review the various products available and can help clients select the best one that fits lifestyle and financial goals.

Understanding the impact of these rising rates

It is possible that rising interest rates are here to stay, but I think it is important to ask the question: Is it just a blip or a trend? For those who believe it is a trend, here are a few important factors to keep in mind in a rising interest rate environment:

1. Affordability. According to its latest quarterly report, RBC says its affordability index reversed course, meaning housing has gotten relatively more expensive, in two of the three categories it measures. Mortgage rates in isolation don’t mean very much. What is really important though is how much your payment is relative to your income.

2. More people will select variable even though they still must qualify on the artificially-set benchmark rate. This is simply a reality of the mortgage business.  I see this trend continuing as long as the Bank of Canada does not raise its overnight rate.

3. Reduced demand for housing may result in lower home pricing. If affordability does become an issue, and more potential buyers are forced to the sidelines, then fewer people will be looking for houses. Economics would then dictate that with fewer people looking and supply remaining constant, this would lead to falling home prices.

4. Short term rush into the housing market for those sitting on the fence.  The flipside to point #3 above is that there are a great many people who have been looking at purchasing.  Rate increases might trigger buying activity out of concern that rates will keep rising and they may be priced out of the market.

5. If rates are on an upward trajectory make sure you get pre-approved with a rate hold as soon as possible. Fixed rates may be on the rise but you can often protect yourself against major increases, on a short term basis, with a rate hold.

6. If rates continue to rise and you originated your mortgage at your bank branch you must shop your mortgage at renewal.  There may be thousands of dollars at stake. This topic has been covered numerous times and there are many tips to be had. (http://blogger.mortgagegroup.com/2013/06/save-at-renewal-time-by-using-mortgage.html)

In the end, market volatility breeds uncertainty but it also brings opportunity. This is an ideal time to talk mortgage strategy with your mortgage professional.  The strategy is vital and is, in many respects, more important than the rate.

It may be time to consider the variable rate or, from a historical context, it may be a great time to consider locking in to a fixed-rate product.  Either way, it’s up to you to be proactive and seek out advice.