The U.S debt ceiling and Canada

There’s lots of talk south of the border as the deadline to raise the debt ceiling looms. Many Canadians are scratching their heads wondering what the heck it all means and should it matter to us. It’s a good question but the answer is complicated. 

Raising the debt ceiling allows the U.S Treasury to borrow more money to fund the business of government. Right now the government is in a partial shutdown, meaning many programs including social programs have stopped operating and workers have been sent home.  Not raising the debt ceiling means the U.S. Treasury will run out of money and won’t be able to cover its bills. If that happened, it would be a historical first.

No one really knows what would happen next. Some liken it to the Lehman Brothers collapse in 2008 that sent the U.S. economy into a recession, with global consequences, only this time it would be far worse.

 “A default would be unprecedented and has the potential to be catastrophic,” a U.S. Treasury report said. “Credit markets could freeze, the value of the dollar could plummet, US interest rates could skyrocket, the negative spillovers could reverberate around the world, and there might be a financial crisis and recession that could echo the events of 2008 or worse.”

That’s not good.

The U.S. debt limit came into effect in 1917 to help Congress pay for World War One. It has been raised periodically to cover any shortfalls in government spending. In 2011, the Tea Party Republicans refused to approve raising the debt ceiling unless certain spending cuts were made – this time the impasse is about Obamacare.

Financial experts suggest that if the debt ceiling is not raised and the U.S. government defaults, the first thing that might happen is that investors will lose confidence and stock markets will fall, not only in the U.S., but globally as well. Borrowing costs will increase and economies will slow down. But those same experts agree that U.S. Congress will likely stop bickering and make concessions to avoid default. 

Last week, President Obama held a press conference sending a message to Congress on how ridiculous it was to keep their “no deal” stance. U.S. business and U.S. markets have sent loud and clear messages to Congress to not push the country to the brink of default. The Republican Party is now viewed favourably by only 28% of Americans, down from 38% in September. This is the lowest favourable rating measured for either party since Gallup began asking this question in 1992.

A  Globe and Mail article on October 16, 2013, questioned if even having a debt ceiling was a good idea. A University of Chicago January survey of U.S. economists found that a majority strongly agree that “a separate debt ceiling that has to be increased periodically creates unneeded uncertainty and can potentially lead to worse financial outcomes.” 

The reason economists don’t like it is because of how much it sets back economic growth worldwide.  Central Banks around the world are already making contingency plans.

Tomorrow, October 17 is deadline day. When one country is a powerhouse for global economic growth and is vulnerable to the whims of one small sector of its constituency, then perhaps the economic model needs to changed.

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.

What’s happening with interest rates?

Interest rates are on the rise.The Big banks have been inching up their rates since May, but have now moved quickly to 5-year fixed rates ranging from 3.79% or 3.89%, which is a 60 basis point hike from what they were six months ago.  The 5 year bond yields have themselves increased by 80+ basis points since the Spring.

However, variable mortgage rates and the prime lending rates are not increasing – yet. So, if you have a line of credit, your rates are staying the same.  If you have a variable mortgage rate or an adjusted rate mortgage (ARM), you’re safe for now.Only fixed mortgage rates are increasing.If you are renewing a mortgage, this is where you’ll likely feel the impact.

If you opted for a variable rate mortgage, today’s variable rates are, on average, around 2.65% compared to 2.1% five years ago. However, 5-yr. fixed posted rates were hovering around six per cent in 2008, but a mortgage professional could get a discounted rate from 4.2% to 4.9%. As fixed rates rise and the Prime rate stays put, now may be a good time to speak with a mortgage professional about the benefits of going variable.

But if banks follow RBC’s lead, then it will be tougher to qualify for a variable rate. The Royal Bank not only increased its fixed rates but also its benchmark rate for qualifying borrowers for variable rates and for fixed rate terms less than five years. The increase is a 20 basis points jump, from 5.14% to 5.34%, which means a household will need approximately $1,100 more income to get a variable-rate mortgage on a $300,000 house with 5% down.

This is also not a good time to wait it out, thinking that rates will come down as they have in the past. It may not be the case this time. Consumers have been getting the message about curbing household debt and have become better money managers.The housing market is showing signs of life and house prices are stabilizing. The economy is moving forward and low rates are just not sustainable anymore.

Fixed rates rely of bond markets. Bond yields are climbing higher so fixed rates climb right along with them. In June, the 5-year yield was up as much as 20+ basis points in less than 48 hours, driven by optimistic economic comments from the U.S. Fed. In CIBC’s Weekly Market Insight for July 12, 2013, chief economist Avery Shenfeld said, “As we move into 2014, better growth will see the Fed accepting a further climb in long rates.”

Stephen Poloz, the new Governor of the Bank of Canada said he would be holding the prime rate at 1 per cent. This is the number banks use to determine their lending rates for lines of credit and variable-rate mortgages. Poloz also added, “Over time, as the normalization of these conditions unfolds [growing economy], a gradual normalization of policy interest rates can also be expected, consistent with achieving the 2-per-cent inflation target.”

That’s a nice way to say that rates will be going up. When is hard to predict,  but all indications are for early-to mid 2014.

Housing market breathes again

After months of somewhat depressing news for the housing industry, Canada’s housing market is showing signs of life. The buzz now is about a soft landing rather than a bubble bursting. Demand has increased in most parts of the country and new construction activity is increasing. Home prices are rising as well.
Despite warnings from analysts about a housing bubble, housing-market data are showing few signs of a sharp correction. A housing bubble is a type of economic bubble that occurs periodically in real estate markets,  characterized by rapid increases in valuations of housing until they reach unsustainable levels and then decline.

Minister Jim Flaherty tightened mortgage rules for a fourth time last year, concerned that an overbuilding of condos could lead to sharp price declines. Former Bank of Canada Governor Mark Carney identified record household debt as the biggest domestic risk to the economy.

However, our low interest rate environment has kept any bubbles or sharp corrections in check.  Now, the impact of Flaherty’s changes seems to be fading.

Households that put their purchase decisions on hold because of the stricter deadlines are now becoming more active. The latest data from Statistics Canada show that the number of homes changing hands is relatively steady, after a period of steep year-over-year sales declines. Even condo developers, who scaled back their activity, seem to be jumping back in. 

Even the Canadian Real Estate Association (CREA) has updated its forecast for home sales activity. May's sales were up 3.6 percent from April, a sign of momentum and the largest month-over-month increase in almost two and a half years. However, affordability may continue to be an issue as home prices tick upwards.

Benjamin Tal, deputy chief economist with CIBC predicts that prices will go down in the next year or two, but not by much. “Prices have held up so far because, as demand has fallen, so has the number of homeowners listing their properties for sale, Tal said in an interview with the Globe be and Mail. “I do not see smoke. I see a boring, slow process over five to seven years that will take fundamentals and prices back in line.”

All the signs point a recovery in the housing market and consumers are deciding to move forward with their purchase intentions. It’s a great time to discuss options with your mortgage professional who can help you navigate the waters of interest rates and mortgage products to find something that fits your financial goals.

Renegotiating your mortgage agreement

It’s a familiar story. You buy a house and lock into an interest rate for a five-year mortgage term. Then something changes in your life midway through the term and the current mortgage doesn’t meet your needs. Or mortgage rates have gone down substantially and you would like some interest rate relief, so you consider renegotiating the mortgage agreement. However, there will be a cost and that cost will most likely determine whether you renegotiate or not.

The first step is to decide what your new needs are. Do you have to move because you’ve been transferred? Do you simply want to renegotiate to get a lower interest rate to ease your monthly payment? Do you need to make some significant home improvements? Have you accumulated debt and would like to consolidate? 

If you opted for a variable rate mortgage, the prepayment penalty may be the least costly. If, however, you opted for a fixed rate, the calculation is a bit more complicated. And different lenders offer different terms and conditions.

Here’s how it works. There are two types of mortgages – fixed and variable-rate mortgages.  For the most part, variable-rate mortgage charges are three months interest. Fixed-rate mortgages have different rules. They use the interest rate differential. Different lenders have different ways of making this calculation but basically it’s the lost interes,t calculated at the current contract rate, minus the market rate at the time the penalty is calculated, for the remaining term.

If at the time of the calculation, the market rate is higher than your contracted rate, then the lender will only charge three months interest penalty. After all, the lender stands to make more money at the higher rate.  However, if the rate is lower, then you get hit with the rate difference.

Some lenders are pretty clear with their calculations, others however are not.  You’ve no doubt heard about penalty fees in the thousands of dollars. Here’s how that happens. Let’s say you have a contracted five-year rate at 2.99% but you want to break it in the second year.  Some lenders won’t use that rate to calculate the differential but will use their posted rate, which is substantially higher.  A posted rate of 5.14 per cent, for example, would create an interest differential of 2.15 per cent. If your mortgage is in the $300,000 range, then the penalty will be in the $10,000 range. That’s a hefty sum.

There are also options to help reduce those prepayment charges. Many mortgage agreements allow you to prepay a certain amount without triggering a charge. You might consider prepaying a portion of the mortgage before renegotiating so your charge is calculated on the balance. But beware; some lenders have rules on how close to the date of renegotiation you can make those prepayments.

If you’re renegotiating because you’re moving, you can avoid prepayment charges by porting the mortgage, which means you take your existing interest rate, terms and conditions to your new home.

If you’re renegotiating to take advantage of lower interest rates, some lenders will allow you to blend- and-extend the mortgage until the end of the term. Your old interest rate gets blended with the new term’s rate. You will probably get charged an administration fee.

There may be benefits over the long term to renegotiating your existing mortgage if it fits with your overall financial goals. It’s always a good idea to get advice from a mortgage broker who can offer options and solutions.

Insights from the poker table

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

After writing a series of blog posts on interest rates, credit guidelines and the mortgage industry, I ventured out a while ago and shared my personal experience as a hockey coach (http://blogger.mortgagegroup.com/2013/05/business-lessons-i-learned-as-hockey.html). I appreciate the feedback I received and was encouraged to post again of a more personal nature. As always I welcome your feedback and comments.

I have long since been a fan of poker. A number of years ago I became a part-time student of the game, Texas Hold-Em, to be specific. I like the combination of playing the cards I was dealt and playing my opponents at the table. I liked the strategy and the math – calculating both my odds as well as pot odds, which is simply the amount that I would have to bet divided by the amount that was already in the pot. At that point I decide if my pot odds are worth it with respect to my odds of winning a hand. I like the thinking, the interaction and the winning --though that part has been few and far between. 

How many times have we all heard sayings like "life is too short" or “you have to live for the moment"? After years of having, and finding, excuses I finally decided to go "to the show" and play in one of the World Series of Poker (WSOP) bracelet events.  I have played some small tournaments and regular games with friends but I always wanted to play in a WSOP event.

The World Series of Poker along with World Poker Tour (WPT) are probably the best known tournament events. The WSOP Main Event takes place each year and has more than 8,000 participants putting in $10,000 each. The event I played in was NOT the main event but it was a bracelet event nonetheless. There were approximately 2,300 participants in the event I played in. The winner, Chris Dombrowski won $346,332 for his efforts. 

Sure, the money involved in winning would have been great, but truthfully, I wanted to play for the experience. I wanted the opportunity to sit in a tournament with thousands of other would-be poker hopefuls trying my luck at the tables with both amateurs and professionals alike.

Over the past ten years or so, poker has become much more mainstream. We’ve had the opportunity to watch the game being played on television and we get to peak at the hole cards.  We’ve become familiar with names such as Negreanu, Brunson, Hellmuth, and Esfandiari. As amateurs we have the opportunity to play with these pros. Other than an occasional golf pro-am I can't think of many other sports (ok, insert laughter here … poker is a sport?) where a casual player gets to play alongside a professional with a chance, albeit very slight, at a great run. Simply put, I had that opportunity and I had to take it.

In the end I was pleased with my play though I was knocked out on my third all-in mid-way through Day 1 with what some people are telling me was only a marginal hand --pocket 10s, short stacked, fifth to act, and one raiser ahead of me. More than that, I loved the experience. I will return, but I will also keep my day job.

 Speaking of my day job, similar to my poker play, I often look for insights for how I can keep improving. When the cards are not coming your way there is an opportunity to practice patience. There are also opportunities to “make your own luck.”  As with poker there are ups and downs in our industry with rates and guideline changes and lenders entering and leaving the marketplace. It is vital to stay focussed. Sometimes when others are becoming more passive there is actually an opportunity to act and invest.

That’s why I am so passionate about mortgage brokers and the mortgage industry. Regardless of the hands they are dealt with respect to credit guidelines, mortgage restrictions, and intense competition from bank branches, they are steadfast in their direction, ensuring that the best interests of the clients are handled first.