Mortgage Investment Corporation Blog
September 24, 2012
Recently I had the pleasure of walking my daughter down the aisle at her wedding. This short journey together certainly will be one of my cherished memories and life experiences. Upon reflection this simple physical act represented in summation the level of support that, as a parent and father, you give to your child. Within the first week of her being married I received the first question about mortgages and buying a home from my newly married daughter.
Based on my now over 30 years of mortgage lending experience this `FOB*` has decided to offer the following advice:
It is only natural to want to consider home ownership as being desirable. As a society it is stressed that home ownership is the fulfillment of one of our pre established lifetime goals. That said, the first step should be to truly have a close look at your own real shelter needs.
This look should include your current shelter situation, short term needs and future potential requirements. During this analysis process you should also take a close look at your potential career paths. This should also consider not only what part of town you may choose to live in but also any potential geographic location changes to your residence. During my own early career as a banker we as a family moved to assume new opportunities no less than six times back and forth over the three Western Provinces. Looking back on that time period your Mother and I have more than once said how fortunate we have been not to have purchased a home in some of the towns and cities we lived in. We have also lamented the sale of one home we sold in Victoria as a result of a job offer and move that I, at the time, felt that I could not say no to. Wanting to purchase a home rather than renting is only natural but unless you own your home free and clear of any debt you are simply renting the money (mortgage) rather the renting the realty. The only real difference is that with home ownership you assume all the financial maintenance costs and responsibilities in exchange for being able to participate in any growth in value. Historically this has proven to be a good trade off as we have in the past seen market values increase at rates that have far outpaced any financial cost of home ownership.
As for the current anticipated growth in the residential housing market most economists are predicting and in agreement that we will see slower growth in values than in past years. You will have many opportunities to enter the housing market over the coming years but your first questions must be:
1. Where do you choose and agree to live?
2. What truly is important to you both in a future home? This should look at both needs and wants.
3. The next part of the process is to closely look at the financial realities of home ownership.
What, Where and How…….
Paul E. Croy
*Father of the Bride
There is the old cliché that goes; “We are living in interesting times”.
In general I have always supported the concept of long term ownership of real estate. Especially when you consider the benefits of having the ability to tax shelter any market gain made in value of your personal residence. As a result, in past years, home ownership became the cornerstone of wealth creation for many baby boomers and their parents. Besides the financial benefits experienced through home ownership, there have been many other indirect social and economic benefits to Canadian society as new residential neighbourhoods were established coast to coast. Meeting the shelter needs of its citizens and helping to create an orderly, stable and affordable realty market has always been a high priority for the Canadian Government. A substantial portion of our national productivity and tax revenues are derived directly from the Canadian Housing Industry. Yes, long term I would almost always agree in the logic of residential home ownership.
Some days my Crystal Ball really does not work as well as other days, however I do feel strongly that we are currently in a buyer’s market and that state will remain as long as we have a disproportionate supply of sellers to the demand of buyers. Many people who purchased real estate five years ago with modest down payments have not seen nor shared the positive experience of seeing their housing dollars grow. In fact some have seen decreases and erosion of their housing equity as a result of declines in market values. This has produced a whole generation of purchasers not being able to sell and repurchase larger homes. Historically this trend to sell and repurchase “bigger and better” shelter is commonly referred to as being a “move up market”. Without an active move up market the entire real estate market “food chain” is affected.
Once again we have seen changes to mortgage qualification rules. To lenders, realtors and purchasers alike these changes have caused some confusion. Effective July 3, 2012 the following new parameters apply to all new insured mortgages:
1. The maximum amortization period is reduced from 30 years to 25 years for insured mortgages.
2. Reduction of the limit on refinances from 85% down to 80% Loan to Value.
3. Debt Service Ratios must now not exceed 39% and Total Debt Service Ratios must not exceed 44%. These are more generous ratios than previously permitted and offset the reduction in the amortization period.
4. Lenders are required to insure that applicants for insured mortgages must have a credit score of 680 for debt service ratios above 35/42.
5. Insured mortgages are now only available on purchases with a price of less than $1 million.
Previous changes to rules regarding insured mortgages had eliminated insurance for any non-owner occupied residential property that was being purchased to be used as a rental property. The end result is that all rental properties and now also any residential property valued at over $1 million requires a down payment of at least 20%.
It is however, important to note that long term mortgage interest rates are now being offered for 10 year terms at less than 4% and are likely to remain low for the coming months. Accordingly, I would recommend that potential buyers continue to consider and focus on the long term value that home ownership offers, continue to save additional funds for a larger down payment and continue to educate themselves as to the current real estate market trends and lastly, decide if now might actually be an opportunity rather than a challenge.
As in many instances in life when you least expect to find something, you may just trip over it.
Paul E. Croy
Over the past year, the Bank of Canada has been warning almost monthly against the dire risk of high consumer debt levels. This warning message is very valid for individuals that have maintained high debt and have little or no tolerance in their family budget for higher monthly payments. Once interest rates do start to increase the end result for some highly leveraged mortgagors will be as though they had built their financial house upon the sand. The tide of promised changing interest rate increases may be not as imminent as predicted but are only delayed.
Against the backdrop of a current risk-filled global environment we should not expect to see any significant interest rate policy change from the Bank of Canada. With Britain tipping back into recession with two quarters of negative growth, the US showing less than stellar job growth numbers and Europe with its continued economic problems, there is no support for the premise of strong economic growth. The US has huge debt and deficit issues, Greece has become a financial basket case while Spain, Portugal, and Italy also carry huge debt combined with high unemployment and slow growth. The Bank of Canada will be very sensitive to our domestic economic growth and how the effect of a potential interest rate increase will affect the value of the Canadian dollar.
As anticipated interest rate increases fail to arrive this spring, lending institutions might be forced to start rolling back mortgage rates increases to gain market share. This could be an opportunity to consider looking at long, fixed term residential mortgage rates as being a safe haven.
In the interim the Bank of Canada will remain waiting in the wings and will continue to rattle its saber as to the evils of consumer debt. The eventuality of interest rate increases is not in question, but the Bank of Canada may be forced to wait until the second act of this economic play before being able to perform based on today’s global economics. As to the timing of the second act my guess would be not until the spring of 2013.
Paul E. Croy
Canadian bankers are, by nature, a conservative lot. This is partly due to the mandated procedures and policies they are given by The Office of the Superintendent of Financial Institutions (OSFI) in Ottawa. The OSFI, reporting directly to the Federal Government’s Minister of Finance, has the responsibility to grant (and also terminate) Financial Institution Operating Charters. As a result, Financial Institutions always seek to have a positive relationship with OSFI, and in turn OSFI always closely monitors the operational integrity of our Federally Chartered Canadian Financial Instructions.
To ensure the soundness of Canadian Federal Financial Institutions (FI), OSFI will take into consideration, among other things: adherence to strict Tier 1 and Tier 2 equity capital requirements; portfolio delinquency rations; asset quality; asset mix requirements; and firm asset and liability matching reporting requirements. An FI is permitted to, with respect to the firm’s asset and liability matching report, ‘mismatch’ up to a maximum of 15% in any given quarter for any given term. This leeway, together with an accurate forecast of interest rate trends, gives FIs the ability to pick up additional interest by deliberately mismatching their assets to their liabilities. FIs will engage in this practice from time to time in an attempt to increase the investment return in their lending portfolio.
Listening to Jim Flaherty, Minister of Finance, several months ago would have left one confident that Canadian interest rates were scheduled to start a slow but steady increase from their current historic lows. In fact, many respected economists were projecting a July or August start date for the anticipated hikes. Due to the ever-changing global financial world we find ourselves a part of, this rate increase never occurred. It would seem that the Canadian economy is no longer insulated from what happens in other parts of the world. In addition to budget problems and unemployment issues that have threatened the fragile economic recovery process in the United States, the debt problems in Europe are mounting. The Global economy’s problems are manifesting in the Canadian economy’s slowing growth and lower inflationary pressures. Accordingly, the Bank of Canada has decided to delay raising Canadian interest rates.
As a result of this revised interest rate forecast, some of the FIs who lend via mortgages have been caught mismatched and are now aggressively lending in an effort to reduce the risk of shrinking interest available rate spreads (interest rate spread is the difference between what an FI pays for its cost of funds and the amount it charges while lending such funds). What we have been seeing recently is very aggressive competition between lenders when it comes to fixed term mortgages. This, together with the industry’s increase in the cost of variable rate mortgages, is helping make fixed rate, longer term mortgages appear more attractive to the mortgage consumer.
We are certainly living in interesting times, and in an economy that is, without question, a true part of the global economy. Yes, economic trends will continue to be volatile. Yes, the ‘big picture’ we must consider before making financial decisions just got quite a bit bigger.
“In investing, as in politics, the easy plausible notion is often misleading.” – John Train, The Craft of Investing, 1994
Paul E. Croy
Recently a friend of mine started a new career as a realtor. She e-mailed me asking for my opinion with respect to purchasers buying with little or no down payment. After I finished my e-mail, I thought it might be worth sharing a few of the highlights on this blog.
There are options available for buyers who can’t produce a large down payment. Several institutional lenders offer Cash-Back mortgage options, however these require the potential borrower to evidence their ability to finance a 5% down payment from their own resources, plus cover any closing costs (which average 1.5% of the actual). Also, lenders will be looking for borrowers with strong credit history, debt serviceability, and job stability, to offset the risk of the smaller down payment. Mortgage insurance may be required, and the insurer can request an appraisal to confirm the accuracy of the market value of the property, which will add a few days to the approval process. (It is also worth noting that institutional lenders will generally lend to the LOWER of the appraised value or the purchase price.)
Another option – and one I’m a fan of – is the RRSP home buyers withdrawal plan. For buyers looking to fund a down payment, this is quite simply one of the best options available to them. If parents will be involved in funding the purchase, it might be prudent to consider participating in matching contributions to their child’s RRSP. This can make the actual process of the gift less painful when the time comes for the actual purchase. The ability to withdraw from these tax-sheltered RRSP funds will be an asset in making a mortgage deal work, and should be a cornerstone of any first-time buyers planning process. (An RRSP which has been systematically accumulating over a period of time can influence a lender’s view of your credit risk and ability, demonstrating good established saving habits.)
If a borrower decides to apply for conventional financing (for a maximum of 80% loan-to-value on a purchase) with the intent of adding secondary vendor take back financing, the lender will require a minimum of 10 – 15% real equity from the borrower. (Historically, default rates are lower when a borrower’s equity is real money saved from individual resources.) During the approval process, the lender will include this anticipated second mortgage in the calculation of both the borrower’s ‘Shelter Costs’ and Gross Debt Service Ratio.
The bottom line is that there are some creative institutional lenders who offer specialized mortgage products for borrowers who don’t have large down payments. However, the interest rates on these products are higher than market on a prime plus basis, there is normally a small fee to the lender, and the restrictions are greater. Lenders with these products are looking for borrowers who – due to lower credit scores and debt serviceability – don’t fall within the bounds of conventional borrowing, but will likely do so by the time their proposed mortgage matures. It should be of no surprise that these products are priced to make additional profit for the lender to compensate for the potentially higher default rate and increased administrative costs.
A note about vendor take back mortgages: because the lender in this situation is, in fact, the seller, it is important to note that they assume a high level of risk. A great deal of care must be taken to fully disclose the risk – I’m not saying that every borrower is bad, but things can and sometimes do go wrong. Clients need to be made aware of these potential risks. There is risk for the buyer, too. There are no guarantees when it comes to refinancing, and neither are they assured that the vendor will still hold the interest in their property – it may have been sold off to fund a Mediterranean cruise, and there are no guarantees that the new mortgagee will be cooperative.
We love it when one size fits all, but I find that when it comes to mortgages, every deal is different. There’s my $0.02 worth, hope it helps.
Paul E. Croy
Many people spend a great deal of their time and energy looking for ‘The Perfect Investment’. Over the past three decades, I have repeatedly had clients actively seek an investment that will produce a steady double digit return risk-free. This ideal investment – high reward for no risk – has become the elusive ‘Holy Grail’ for most investors.
Too many investors, following the latest hot investment tips without doing proper research, end up disappointed, disillusioned, and potentially demoralized when confronted with their losses. Even smart investors are too easily motivated by greed and don’t use common sense when confronted with a ‘get rich quick’ investment scheme that sounds too good to be true.
The simple truth is that every investment carries risk. Even not investing carries risk – inflation can decrease the value of your ‘nest egg’ and reduce the purchasing power of your money! The first step, and the key to successful investment, is fully understanding the risk you are exposed to and using management tools such as portfolio diversification to reduce your overall investment risk.
The next step to becoming a successful investor is to stop listening to others for financial advice. You know the kind: the advice offered at social gatherings and in break rooms, from people who, quite frankly, really don’t understand what they are talking about. Have your own investment rules and stick to them. These are rules and guidelines you establish to stop you from making rushed emotional investments which almost always end in a loss.
Cultivating investment mentors – successful long term investors whose opinions you trust – is the final and, in my opinion, most important step in the process of becoming a successful investor. If you ask these mentors for investment recommendations, be prepared to really listen, as these sources should have no ulterior motive. Your best mentors will often be close friends and family members. In some cases, they may offer you the name of a trusted Financial Advisor, or share what I call ‘established investment truths.’ These truths are the rules of investing that they have successfully used over the years. A few of these successful investors might even recommend that a portion of your diversified investment portfolio be invested in shares of a first mortgage MIC such as First Accredit Mortgage Corp. They might even say that it’s as close to a perfect investment as they have found.
Paul E. Croy
A recent survey done on behalf of (RBC) Royal Bank of Canada indicated that the majority of potential first time home buyers in Canada have decided to delay their entry into the world of home ownership for one year. A general lack of confidence in the current market, the potential volatility of interest rates, and recent changes to the mortgage lending qualification rules for high ratio financing are all factors that have contributed to this collective decision.
Many industry professionals will agree that we are currently in a buyer’s market. As we start to enter the spring market, traditionally one of the most active times of year in Real Estate, sellers may wind up disappointed. Many of the first time home buyers of a few years ago, who have built up some equity in their property value and are now looking to sell, need a strong first time buyers’ market in order to move up the property ladder. Once they sell, they become the ‘move-up’ market. This has, historically, been the natural progression of an orderly real estate market. In simple terms, it is very much like a food chain. The move-up market is dependent upon the existence of first time home buyers.
A majority of Canadian economists agree that the Bank of Canada is expected to begin to slowly raise interest rates later this year. My best guess is that this gradual rate increase will start this coming August. However, based on what I think will be strong competition within the mortgage lenders as a result of a slower spring market and, thus, a lower demand for financing, I feel that many lenders will be forced to decrease their five year mortgage rates to be competitive in this market. Looking at the current five year mortgage interest rates and five year Canadian Bond Rate interest rates, it is clear that lenders have the ability to maintain satisfactory profit margins while decreasing their rates.
While many potential first time home buyers may want to sit back and wait a year to perhaps study the market and the changes in lending rules that have been forced upon us, the bottom line is they may very well miss an opportunity to take advantage of lower interest rates and realty prices. With a delay of one year, potentially higher interest rates and a more competitive market may mean the home you are seeking to buy might come with a larger-than-expected price tag. Sometimes it pays to be a contrarian, and this may just be one of those times.
Paul E. Croy
Institutional lenders, such as banks, are starting to collectively jump on the band wagon to increase mortgage interest rates. They are once again chanting their mantra about inflation concerns, higher costs of funds, and tighter interest spreads while at the same time restating the need for Canadians to reduce their personal debt levels. As a result of these actions, banks should make more money for their shareholders. I’m also sure that a few senior bankers might take home a larger performance bonus. In my opinion, the best interests of the mortgage consumer really have not been well served by these actions.
The Bank of Canada always attempts to make available an adequate supply of money to satisfy the market demand for residential mortgages. At the same time, Canada Mortgage and Housing Corporation (CMHC) works very hard to stimulate and educate our housing market while attempting to make residential home ownership opportunities available to a broad section of our society. Policies developed by the Minister of Finance are directly aimed at maintaining an inflation rate that will insure the long term economic value of home ownership. With the Canadian core inflation rate being reported now in the 1.5% range, the strategy of home ownership will certainly help to provide a strong and stable financial future for many Canadians. When our government considers the future, looking at potential options to deal with pension short falls and the growing cost of health care, it should be no mystery that a healthy and stable housing market is very important to our economy. Economic policy will be crafted in Ottawa with this in mind. With core inflation well in line and a very strong Canadian dollar, the need to raise interest rates might seem just a bit redundant.
Recent trends in the mortgage rules have not made the dream of home ownership easier. Combined with the credit industry’s trend toward centralized approval systems, most financial institution staff have not been given the opportunity to develop the knowledge or skills required to adjudicate or understand credit risk. I, for one, enjoyed a time in the not so distant past when a branch manager had interest rate discretion and the ability to grant mortgage approvals based on local market knowledge, experience, common sense and sometimes just a gut feeling. This style of lending may today seem old fashioned, but it was more in the borrower’s best interest.
Paul E. Croy
As Christmas soon approaches I, for one, have simply decided to take a vacation from the daily negative public feeding of Grinch Economics 101. No, I don’t plan to be singing around the Christmas tree with the entire population of Whoville, but for just a short time I’m giving myself permission to simply stop listening to the constant bombardment of negativity that the media seems so fond of producing. Just for a short while, I am choosing to look at the more positive aspects of living such as friends, family and the meaning of Christmas. For many, this will also be a time for reflection and the opportunity to look forward to making positive financial and personal changes during the coming New Year.
The world’s economic problems will all still be there when I refocus my attention. Sadly, solutions to the stagnated global economy will, in my opinion, be long term and still somewhat painful. The solutions to our Canadian recessionary issues will be easier found and eventually we will emerge from these years of weaker growth and poor economic performance.
In the interim, Canadian residential mortgage interest rates should remain at historic lows for the foreseeable future and next January our credit card bills will still arrive in the mail. One of these two events I look forward to along with Christmas.
Paul E. Croy
Many of today’s young adults are still living with their parents. In fact, 17% more of Canadian young adults born between 1970 and 1990, known as Echo Boomers, still find themselves living with their parents. This is in part due to the recent economic and financial crisis, but also in part due to a trend in the children of Baby Boomers to simply delay the development steps of marriage and home ownership. These Echo Boomers account for 9.2 million young Canadians who have also been call the Boomerang Generation. For some reason I don’t think the term boomerang has anything to do with travels to Australia.
In one generation, we have gone from 33% of young adults (Baby Boomers) living with parents to the now record 50%. Past generations tended to get married earlier, start careers sooner, and buy houses pretty much as a scheduled series of events. The Echo Boomers, however, tend to delay both getting married and homeownership.
Over the coming years, this group of 9.2 million potential consumers will certainly become targets to be marketed to by the realty and mortgage industries. The industries will stress the lifestyle and financial advantages of home ownership to this unique, well-educated group:
-> 97% own a Computer (the same percentage that also use social media every day.)
-> 94% own a cell phone (and perhaps will never own a traditional land line telephone.)
-> 56% own a MP3 Player (I will have to ask my kids what that is, I might even own one!)
-> 40% of Echo Boomers chose television as their main source of news. (I’m sure that you can guess where some of the advertising dollars will be spent.)
-> Most use Email, text, Facebook, MySpace, UTube and Twitter to communicate.
The dream of home ownership is still very much alive in Canada. This Echo Boomer generation has only delayed homeownership rather than eliminating it. When they do buy, they will buy as a demographic group and are sure to become a major force in the Canadian realty and mortgage market. In the interim, perhaps we Baby Boomers can still have help solving computer problems while the Echo Boomers still live at home.
On a side note, one other interesting statistic is that, on average, this group of Echo Boomers speaks with their parents 1.5 times per day.
Paul E. Croy