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.

Interest rates dominate headlines again

By Mark Kerzner
President TMG The Mortgage Group

It seems as though we have come out of the gates of 2015 with a bang!

Just when we thought we turned the subject of front page news over to the OIL industry, it seems to have come back full circle to mortgages and interest rates.

As a nation, we have never seen bond yields and the overnight rate at these low levels. And the cost of funds inherent in those two areas have resulted in historical low rates for both variable and fixed mortgages. In addition, it is very rare when the yields on the 5-year bonds, and the return that regular investors earn on government guarantees, is actually lower than the overnight rate. That’s the case at the time of this writing (bond yields at 0.64% and the overnight rate at 0.75%). This usually implies some rough economic times ahead. 

What is remarkable though, is that with the latest 0.25% reduction in the Bank of Canada overnight rate the banks chose to lower their PRIME rate(s) by only 0.15% thereby 'banking' the difference as enhanced margins
To put that move in context; never before have banks moved their PRIME rates by less than 0.25%. At the same me time the banks lowered the interest rates they pay on savings and investment accounts by the same 0.25% that the Bank of Canada lowered its overnight rate.

The banks have collectively said their margins are under pressure and this was an opportunity to alleviate that. On the one hand, it’s interesting to me to see the banks continue to erode their own margins by heavily discounting rates when their margins are eroding. On the other hand, when they lower the PRIME rates they are lowering the rates on a portfolio basis as opposed to when they decrease discounting on an ARM, which is reflected in only subsequent new deals put on the books.

That said, I simply cannot imagine a day when the Bank of Canada has to increase its overnight rate and the banks 'collectively' say, "My margins are large enough so I am just going to keep the PRIME rate lower and not raise it (by the full amount)."

I find the argument that the banks are mitigating a potential housing bubble and protecting the Canadian consumer from overextending very difficult to accept.  If that were the case they could simply set limits on rate buy-downs and discretionary pricing.

There is a silver lining for us as brokers in all of this news. Can you imagine the conversation a first time homebuyer would have going into a branch to discuss the impact of the news of the day on their buying decision? Now picture the same conversations taking place with an educated, professional, full time mortgage broker. As uncertainty abounds, it is absolutely vital that mortgage consumers seek out the expertise of a broker to navigate their mortgage financing needs.

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.

Can you afford to buy a house?

With rising interest rates, overvalued real estate and a lackluster economy, are first time home buyers and average income households being priced out of the housing market. Perhaps. Now that five-year fixed rates have increased two-thirds of a percentage point or more – up from 2.89% to 3.79% -- in the past month, first time buyers may find their dream of owning their first home out of reach, for now.

It was getting tougher to qualify for a mortgage when the government made changes to the rules, but now it seems to have solidified with the recent rate increases. There are other challenges as well. When qualifying applicants lender look at ratios to determine the percentage of household income that is allowed to go towards housing costs – that ratio is approximately 32%. The average non-mortgage debt load is approximately $28,000.

So, let’s say you have an average income of $70,000, your credit score is in the 700s, which is good, and your debt load is $28,000. You are looking for a modestly-price home because you don’t want to be house poor and have managed to save $15,000, which is 5% of a $300,000 home.  At the current 5-year fixed rate of 3.59%, amortized over 25 years – you don’t qualify. If we could amortize over a longer period, which we could a couple of years ago, then your housing costs ratio would fit, but your total debt, which includes your housing costs and all your other debt would disqualify you.

What could you afford? A mortgage of $213,000.  Depending on where you live in Canada -- that may not be an option. An affordability review of the real estate market across Canada by RBC shows that, nationally, the condo market is affordable with housing costs approximately 28.1%. However, costs for two-storey houses eats up to 48% of household incomes, with Vancouver coming in at 87.2%, Toronto and Edmonton at 62.7%. The most affordable cities have housing costs at 34.4%. The most interesting finding is that these affordability numbers have been pretty much the same since1985. Although Vancouver and Toronto are above their long-term affordability averages, those averages have always been above 32%.

So what can you do? There are options – paying off debt is the big one. A mortgage professional will be able to guide you, offer you options and devise a plan to help you achieve your dream of home ownership.
What will happen next in the housing market? No one can predict that, but some analysts believe that prices will start coming down. They also believe the economy will start to grow again next year as the world economies finally emerge from a prolonged recession. That would be welcome news for Canada, where growth has stagnated. It would mean better job prospects and higher earnings and a thriving economy.

Mortgage rates may not go down, but higher earnings, and less debt means you will be able to afford the house of your dreams.

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.

Low rates, recession and debt

The Bank of Canada has recently kept its benchmark lending rate at 1% so the banks have kept their Prime lending rate at 3%. Fixed rates are heavily discounted – a posted rate of 5.39% can be had for 3.59%. Lines of credit are at Prime plus .50 or plus 1% depending on the lender.  However, this cheap money is not without its costs.

Canadians are now carrying an enormous amount of debt, not only in mortgages but in non-mortgage debt, including credit cards, personal loans, lines of credit, etc. This, despite the warnings from policymakers of the danger of carrying these debt loads if interest rates do go up.

Are we heading for a recession as some newspapers and other media suggest? One economist thinks we’re already in a recession. Derek Burleton, deputy chief economist for TD said that we are in a “balance-sheet recession that will take years to shake off so interest rates will stay low for a very long time.”

Even the Wealthy Barber David Chilton has jumped back into the fray with his latest book warning about the dangers of saving too little and taking on too much debt.

With 24/7 news, our financial state of affairs gets far too much analysis, and we get very contradictory statements. It’s not all doom and gloom. A recent poll found that most Canadians feel they have their debt situation under control. And a majority of those polled saw paying down their debt as more than or just as important as saving for the future.

The bottom line is this: Cut your debt while you’re still working and interest rates are low. When rates to go up, you won’t be handing over your well-earned money. Instead, you’ll be on the receiving end because you’ve invested wisely.

And with mortgage interest rates so low, it’s easier to reduce mortgage principal since more of your payment is going to principal rather than interest -- look at the low rates as a way of owning your home free and clear sooner.