Jobs an indicator of healthy economy

Canadians have heard it often during the past four years – the economy has weathered the global financial crisis and came through it with flying colours. The economy has grown and thrived without the disasters that befell other countries. The dollar is strong, the housing market hasn’t busted up despite warnings of bubbles. The GDP is growing, the rate of inflation is slow and interest rates are low. Although low rates have fuelled the economy to some extent, consumers have been reining in the pace of its debt accumulation after warnings from government of the potential dangers of  servicing high household debt.

One of the main indicators that point to a continued healthy economy is the job numbers. Without jobs, household budgets get tighter, consumer purchases slow down, manufacturers scramble to reduce inventory, which could lead to lay-offs, and bankruptcies rise. Job loss is also the leading cause of mortgage default.

Three reports this month – one on manufacturing, the other two on jobs -- show that Canada is still on track to continue its growth – albeit at a slower pace. This is happening despite the continuing crisis globally. Interstingly, Canada is benefitting from an increase in U.S consumer demand, especially for autos.

Bucking the global trend, in June, factory orders rose, according to an RBC survey. The RBC Purchasing Managers Index – considered a leading indicator of manufacturing business conditions — inched up to 54.8 last month in Canada, its highest level since last September. A figure above 50 indicates manufacturing is expanding, while a figure below 50 indicates the sector is contracting.

Then, CIBC released its Employment Quality Index, which found the Canadian economy created 155,000 new jobs in the first six months of 2012 and these were high quality jobs. Another good sign was that full-time employment rose by 1.1% during the first half of the year -- ten times faster than growth in part-time employment. And the number of jobs in high-paying sectors rose 1.6% -- more than double the pace of low-paying sectors.

Statistics Canada’s release saw an increase in jobs in the public sector – 7,300 more people were working in June, much stronger than the 5,000 number forecasted by analysts. That number is not quite as high as the number of new jobs created in previous months, but still, it's not bad.

The report also showed the public sector gained 38,900 jobs in June and full-time employment rose by more than 29,000.

While these are good numbers and show a healthy, growing economy, there have been cuts in information, culture and recreation. The agricultural sector lost 20,000 jobs and manufacturing declined by 800.

Consumer spending accounts for approximately 60% of the economy. So far, even with the anticipated softening, as longs as job numbers continue to increase, the economy will continue to weather the storms and is well-positioned to improve when global economies turn around.

Could US fallout account for recent mortgage changes?

Canadians have, on average, 15 years left on their mortgages, according to a survey released last week by BMO Bank of Montreal. And, according to a recent editorial in the Globe and Mail Canadians hold more than twice as much real estate and almost four times as much equity in it than Americans. The latest Environics Analytics WealthScapes data, found the average household net worth in Canada was $363,202 in 2011; in the U.S. it was $319,970, making the average Canadian household more than $40,000 richer than the average American household.

Yet, we keep getting dire warnings that we are financially overextending ourselves and increasing our debt load. We hear talk of housing bubbles and market crashes. And yet our dollar remains strong, our GDP has increased, our resource sector is hot and our job numbers are going up, albeit at a snail’s pace, but going up nonetheless.

Canadians have been, traditionally, more cautious than Americans. However, in recent years, we have loosened the hold on our own personal financial policies and started to spend, not unlike American households did before its economic downturn in 2008.

Canadians also learn quickly. When the messages about the increases in household debt started to appear in media reports, coupled with warnings from the government and the Bank of Canada, consumers listened and started to curb their spending and made plans to decrease their debt. However the government did not believe it was happening fast enough and implemented changes to curb spending, especially as it pertained to mortgages.  Perhaps the Minister of Finance knew something we didn’t.

Last week, CBC Canada reported the findings of Nanos Research that showed how Americans dealt with the economic downturn – it wasn’t a pretty picture. Economic numbers from the US Census Bureau show that between 2005 and 2010, American households lost 35 per cent of their average net worth. It points to two things: the decline of U.S. real estate values and changes in the stock market.

Perhaps Finance Minister Jim Flaherty’s saw this as an omen for cities such as Vancouver and Toronto, where housing bubbles could be a concern. And despite media reports questioning his reasons for making the latest round of mortgage rule changes, it might be as he says -- protecting Canadians with high debt loads against the eventual rise in interest rates.

Fixed rate mortgage accelerator strategy

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

When I worked as a lender we saw a lot of Adjustable Rate Mortgages (ARMs) - variable rate transactions. From the early-to-mid-2000s that product seemed to be the mortgage product of choice by the brokers we worked with.

Many brokers devised strategies to demonstrate how the ARM was more advantageous to the homeowner than a standard fixed rate mortgage. The "pitch" ranged from paying less interest, to having lower payments, to aggressive principal reduction, and so on. With the benefit of hindsight, for those consumers who chose variable rate products throughout the last decade, they have, for the most part, come out well ahead.

With fixed interest rates continuing to hover at historical lows (5-year fixed rates are approximately 3.09% to 3.29% at the time of this writing) and the small spread between discounted ARMs and fixed rates right now, consumers are choosing fixed rate mortgages. The main advantage for choosing a fixed rate is that payments and rates do not change over the term of the mortgage. The most popular term is the 5-year fixed, although the 10-year fixed rate is starting to take on some momentum of its own.

A couple of years ago the Government of Canada began changing mortgage qualification criteria. One change was to use a benchmark interest rate to qualify buyers for ARMs and for fixed terms less than five years. The benchmark rate is tied closely to the bank’s posted 5-year rate, which is currently 5.24%.

The reason for this change is that ARMs and shorter term mortgages are vulnerable to higher interest rates when the mortgage renews. By building in a buffer, in this case making sure clients qualify at the higher benchmark, then at renewal, if the interest rates have increased, there is less payment shock. It also ensures that mortgage holders would be able to afford higher payments. That interest rate buffer now sits at more than 2% for clients taking out ARMS for terms less than 5 years. That means if you choose to take one of those products you have to be able to make payments on them if rates were to rise by 2%.

Once a client has decided to take a fixed term mortgage as opposed to an ARM then the next question is what term to take. Generally speaking, the longer the term you choose, the higher the interest rate. The rate for a longer fixed term may be higher but it also offers greater security against a  future rise in interest rates. My advice to all mortgage consumers today would be to set your payments as if you took the 10- year term whether or not you select that product.

If selecting a fixed rate product is similar to purchasing interest rate insurance, then purchase the insurance that is likely to pay you back in the end. If the amount of “insurance” you pay during a term results in a lower principal balance at the end of the term than that is like being paid back at the expiry of your mortgage term.

Here is an example:

Let’s take a conventional 5-year mortgage, which is under 80% loan-to-value, which also means there are no additional mortgage insurance premiums. Let’s assume a mortgage amount of $250,000 amortized over 25 years. Payments are monthly, compounded semi-annually. The seven and 10-year terms illustrated below are examples if you were to set your payments on your 5 year fixed term at the corresponding rates of each of the 7 and 10 year terms. The Total Payments and Balances at Maturity are the amounts at the end of five years.


Term        Rate        Monthly P&I       Total Payments         Balance at Maturity
5-year        3.29         $1,220.63          $73,237.80               $214,863.60
7-year        3.69         $1,273.38          $76,402.80               $211,430.47
10-year      3.89         $1,300.19          $78,011.40               $209,685.57

As illustrated above you are paying more over the life of the term but you are also accelerating the principal repayment by an even greater amount.  More aggressive strategies would have you setting your payments at the benchmark rate, which is the rate that the government is suggesting all consumers should be qualified at. If you choose, and can afford this option, you will benefit by aggressively paying down your principal during the current term. That will create numerous options for you down the road including;

1. Greatly reducing the amount of interest you pay over the life of your loan.
2. Significantly reducing the number of years it will take to repay your mortgage in full.
3. Providing you with options at (term) maturity. For example, you may decide to change the amortization to free up cash flow.

There is also another way to get the benefits without burdening your cash flow-- simply choose the accelerated bi-weekly payment options. This means you are making set payments every two weeks, which comes out to 26 payments a year.

If cash flow permits, consider combining the 10-year payment option with accelerated bi-weekly payments for added savings and balance reduction.

These options do require necessary cash flow and in many cases money may be tight right now. The beauty of a fixed rate mortgage option is that you can start this strategy at any point. If times are tight right now you can start in a year or two.

There are so many options to consider when dealing with mortgage products and there is an option that fits your individual need and situation. Talk it over with your mortgage broker.

Mortgage changes concerns for borrowers

The Department of Finance has posted this Q A on its website.

Q. I already have an insured mortgage. How will these changes affect me?
A. Mortgage insurance is good for the life of the mortgage. Borrowers renewing their insured mortgages will not be affected by these changes. For example, if a borrower had a 30-year amortization and there are 27 years remaining on the mortgage, the mortgage can be renewed with a 27-year amortization, as long as no new funds are being added to the mortgage.

Q. What is required to qualify for an exception to the new parameters?
A. The new measures will apply as of July 9, 2012. Exceptions will be made to satisfy a binding purchase and sale, financing or refinancing agreement where a mortgage insurance application has been made before July 9, 2012. While the changes come into force on July 9, 2012, any mortgage insurance applications received after June 21, 2012 and before July 9, 2012 that do not conform to the measures announced today must be funded by December 31, 2012.

Q. Will a purchase and sale agreement dated prior to July 9, 2012 be considered binding if there are outstanding conditions that have not been fulfilled prior to July 9, 2012?
A. Yes, if the date on the purchase and sale agreement is earlier than July 9, 2012, and a mortgage insurance application has been made prior to that date, the new parameters will not apply, even if the conditions of the agreement have not been waived.

Q. Will the new refinancing rules allow a borrower with a mortgage above 80 per cent loan-to-value (LTV) to refinance by extending the amortization period?
A. No. Effective July 9, 2012, borrowers will not be permitted to refinance a mortgage above an 80 per cent LTV, unless the borrower has a binding refinance agreement dated prior to July 9, 2012, and a mortgage insurance agreement has been made prior to that date. 

Q. I have a written mortgage pre-approval from a lender, dated before July 9, 2012 with a 30-year amortization. Will I still be eligible for a 30-year amortization if I don’t sign an agreement of purchase and sale until July 9, 2012 or later?
A. No, a mortgage pre-approval without an agreement of purchase and sale is not sufficient to qualify for a 30-year amortization. You may have a 30-year amortization only if your agreement of purchase and sale is dated before July 9, 2012 and you have made a mortgage insurance application before July 9, 2012. You may wish to discuss with your lender to revise your mortgage pre-approval using the new parameters announced today.

Q. Will the new parameters apply to assignment (“switch” or transfer) of a previously insured loan from one approved lender to another?
A. No. As long as the loan amount and amortization period are not increased, the new parameters will not apply to a switch/transfer/assignment of the mortgage to a different lender.

Q. If I sell my current home and buy another, will the new parameters apply if I transfer the outstanding balance of my insured mortgage to the new home?
A. As long as the outstanding balance of the insured loan, the LTV ratio and the remainder of the amortization period are not increased, the new parameters will not apply when the mortgage insurance is transferred from one home to another.

Q. What if I need to increase the amount of my insured loan when I sell my current home and buy another?
A. In this situation, the new parameters will apply for any insured loan.

Q. If I bought a condo that is not expected to be built for another two years, will the new parameters apply?
A. If you bought a condo and have made a mortgage insurance application on or before June 21, then the new parameters would not apply. If you buy a condo and make a mortgage insurance application after June 21, the new parameters will apply if the mortgage loan is not funded by December 31, 2012.

More changes to mortgage rules

 Guest Blog by Mark Kerzner, President of TMG The Mortgage Group Inc.

The current round of mortgage changes introduced by Minster of Finance Jim Flaherty today, June 21, 2012 took me by surprise.

First a brief recap of the changes:

1. All changes are in respect to insured mortgage loans 
2. Reduction in the maximum amortization from 30 years to 25 years
3. Reduction in the maximum amount Canadians can borrow to refinance their current homes from 85% to 80% loan-to-value
4. Mortgage customers are going to be qualified on maximum gross debt service ratios of 39% and total debt service ratios of 44%
5.  Maximum property values to qualify for mortgage insurance must be less than $1 million.
6.  These changes are going to come into effect on July 9th as opposed to previous announcements that any changes would come with 60 days notice
7. These changes are in addition to the changes previously announced by OFSI about limiting the maximum loan-to-value on HELOCs to 65%

What are the implications of these changes?

According to published reports of leading economists these changes are going to help facilitate a "soft landing". Many are commenting that they are prudent given the continued run up of the debt-to-income ratios and extended period of ultra-low interest rates.

My concern is that these changes have targeted first time homebuyers to a much greater extent which could have a more significant impact on the housing market in Canada. I still believe our housing market, our financial system and our national economic health are all very strong but there are implications.

Moving amortizations from 30 years to 25 years is NOT the same as when they were reduced from 35 to 30 years. For example:

A $250,000 loan amount for 5 years with fixed interest rate of 3.29% the monthly P&I payments are as follows:

25 year amortization = $1,220.63
30 year amortization = $1,090.44 (The monthly cash flow difference between 25 and 30 years is $130.19)
35 year amortization = $999.86 (The monthly cash flow difference between 30 and 35 years is $90.58)

In this example the delta between the two is nearly 30% - a significant difference. In an economic report released this morning from CIBC it was estimated that "the direct impact of this move alone might cut the value of mortgage originations by close to 2%."

In January of this year, CIBC published a report showing that debt-to-income ratios were skewed towards habitual borrowers. It went on to say "A rising share of the highly indebted are over 45 years old, an age where accumulating net assets ahead of retirement should be paramount. Canadians nearing retirement, who should be in their prime savings years, are, instead, getting themselves deeper into debt." This is clearly not the same group most affected by today’s change in policy.

Reducing maximum amortizations by another 5% will make the cost of borrowing more expensive for mortgage consumers who are on the margins. For those who, in the past, used this opportunity in a prudent manner to consolidate higher interest credit then used the cash flow savings to more aggressively retire debt, those options have just been reduced.

For those borrowers who do need to refinance and who are now unable to will seek out more expensive private, unsecured lending products and credit cards to do so. When you consider such a high percentage of mortgage refinance dollars were spent on home improvement and consumer spending, I am concerned about the impact of this change on the economy as well.

Setting a $1 million mortgage insurance limit on property values is clearly going to target the larger urban areas such as Vancouver, Calgary and Toronto.


Why did these changes come into place?

Clearly the extended ultra-low interest rate environment we have been experiencing lately has spurred borrowing and had a positive impact on home prices across Canada. The Governor of the Bank of Canada, Mark Carney had been hinting at his desire in recent months to raise rates. This change gives Carney room to NOT raise interest rates. In fact, if the global economy does worsen, he may, in fact, have the ability to lower rates. A TD Economics report released today asserted that the tighter restrictions can target the risk more directly and have roughly the equivalent impact to a 1% increase in interest rates.

The global economy is still in bad shape.  While we have all been reading the headlines about Spain, Greece, the elections in France, etc., our world financial leaders must believe we are in for prolonged economic recession. As such, there is no time soon when interest rates are likely to rise. The Government decided to target the mortgage debt as a means to deal with the Bank of Canada's inability to raise interest rates.

I am disappointed, though. It was just two short months ago on April 10, 2012 that Flaherty was quoted as saying "I have no present plans to intervene in the housing market in Canada…there has been some moderation in the market of late. I would prefer the market itself to correct to the extent a correction is necessary."

 This reminds me when former US President George Bush said "Read my lips, no new taxes."

What do we do now?

I believe more strongly at this moment than ever, that Canadians should and MUST consult with a mortgage broker. After all, there is no channel more knowledgeable and informed than the broker channel in Canada. Secondly, changes are happening fast. There is no 60-day notice period. If you want to purchase or refinance, talk to your mortgage broker today.

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Few changes to mortgage rules…so far

The anticipated mortgage rule changes haven’t materialized – yet. Maybe it was the strong messages from insiders in the mortgage industry that helped the Office of the Superintendant of Financial Institutions (OSFI) take a softer stand on new mortgage underwriting rules, a move that should lessen the fears of banks and mortgage brokers. 

The contentious issue around requalification for renewing has been shelved for the time being. Mortgage brokers had feared such a rule could cause some people to lose their homes. Banks tend to focus on a borrower’s payment history, as opposed to rechecking income levels or property values, when mortgages come up for renewal. Lenders were worried that renewals would be denied if either of those elements had deteriorated since the consumer took out their mortgage, said Jim Murphy, head of the Canada Association of Accredited Mortgage Professionals (CAAMP) in an article in the Globe and Mail.

Home equity lines of credit (HELOC) products have been capped to 65% LTV – not as bad as what was originally bandied about. The original proposal was that banks would have to amortize these lines of credit. Now, HELOCs can continue to revolve, as opposed to forcing consumers to pay them back within a shorter time frame.

Some industry watchers suggest that firmer rules are still coming. One in particular srrounds the use of automated appraisals. Banks often use automated appraisals rather than human appraisers because software is cheaper and can be turned around quickly. It looks as if OSFI will be watching this very closely and lenders are already upping their requests for on-site appraisals, which, some fear, may result in lower valuations.

Once again, we need to caution the government and OSFI to tread carefully with these changes. The changes are in part an effort to try to prevent another housing crisis like a subprime mortgage disaster. I think it’s time we put the “subprime” disaster and “bubble” fears to bed. While the new guidelines are intended to cool the country’s overheated housing market, the market has been correcting itself. It’s unfortunate that decisions are made on reports and data that are based on what has happened previously rather than on what is currently happening.

We have an economy that is already slowing down, despite low interest rates; household debt is becoming more manageable as consumers have made it a priority to pay off credit cards and loans; and consumers are becoming more financially aware. 

OSFI, the Bank of Canada and the government need to tread carefully. So far, Canada has managed to keep the economy strong and growing, despite the global crisis – let’s not stop that forward momentum.  OSFI will release its final guidelines with regard to mortgage lending, likely in July. We can only hope that the changes, if any, will keep the economy growing and not dampen it completely.

Where’s the tipping point?

Guest Blog by Mark Kerzner, President, TMG The Mortgage Group
 

We have a new development in the mortgage industry. We have The Office of Financial Institutions (OFSI) looking at exerting their newly-given influence on the mortgage guidelines in Canada.  The fact that OFSI has been granted additional responsibilities that include oversight of key lending guidelines -- vis-a-vis what CMHC will insure and therefore what the banks will lend on -- seems to simply be a catalyst to accelerate additional guideline policy changes. Make no mistake about it; these were discussed long before OFSI came onto the scene.

The Government made a number of credit changes following the Global Economic Crisis to instill more responsible lending practices and reduce the risk of a similar housing meltdown that was experienced in other countries, including the US. In retrospect, those changes -- reducing maximum amortizations, increasing down payment requirements on rentals, reducing the amount you could refinance, etc., were prudent. After all, house prices continued to appreciate, real estate activity remained strong and arrears levels remained muted.

And even more recently (since January 2012) we have seen the banks further tighten their own lending guidelines in the absence of formal required changes as set out by the Minister of Finance. An example would be the additional tightening of the Business-for-Self and Equity programs.

The Canadian economic recession was relatively short lived following the global economic meltdown. In fact, Canada was the first significant country to increase its overnight rate in June 2010. The Bank of Canada continued to increase it three more times in the summer of 2010 to 1%. So, given we have already survived the various credit and qualification changes and our market has remained strong, why am I concerned at the prospect of further tightening?

For me, it starts with this question: Where is the tipping point? What change will cause our market to slow down, which is the obvious goal, and what change could cause our market to head into a tail-spin? Or will the market remain the same whether changes are made or not? I don't have the answer for this but the last time I felt this way I was playing PLINKO with my kids not knowing which straw would cause the remaining balls to fall.

My sense is that if there are additional changes focussed on ensuring affordability and suitability -- that would make sense. Those are responsible changes. However, if as an industry, we have to re-evaluate how a renewing customer who has a perfect repayment history has to requalify for a mortgage - that is worrisome. That is the type of change that, in its worst case scenario, could force an increase of supply of homes in the market from people forced to sell because they can no longer qualify BUT who had no intention of defaulting on their mortgages.

Changes focussed on refinances and renewals may impact those with a proven ability to make their payments.  It is not impacting potential supply (ie. new construction) but existing supply.  On top of that, a large percentage of additional funds taken out in refinances are used in home improvements, which increases the value of the property, and for consumer spending. A slowdown of either of these two components could prove problematic. And let us not forget that guidelines now require a minimum of 15% equity for a refinance – up from 5% just a few short years ago.

I understand why a slowdown is desirable. I have heard some experts say, "If there isn't a slowdown it makes a crash more likely.”  I get that, and I support that position. I just want to ensure that a manufactured slowdown targets habitual borrowers and not the demonstrated responsible ones.
 
There are more guideline changes and restrictions coming. The Bank of Canada, the Minister of Finance and many regulators would like to see the Canadian housing market cool off. However, changes must be stress tested against the worst case scenario, which would be triggering a market collapse.