Mortgage Investment Corporation Blog
Canadian Mortgage Rates and the World Financial Market
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
Buying Real Estate without a Down Payment
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.
Kind Regards,
Paul E. Croy
A Perfect Investment
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
When patience might not be a virtue.
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
In the Borrower’s Best Interest
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
Grinch Economics 101
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
When Echo Boomers Buy
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
Pulling a Rabbit Out of the Hat
Lately, many people have questioned the decision by the Governor of the Bank of Canada to raise interest rates. The truth is the Governor has simply been doing what is required to work a little Made-in-Canada economic magic. What the Bank of Canada is doing is an act of balancing today’s need for economic stimulus against the long term requirement for both inflationary and monitory stability.
Over the years, we have seen both hot and cool real estate markets and heard the terms buyer’s market and seller’s market. It is interesting to note, however, that since the three recent increases in the bank rate, residential mortgage rates have been declining. It is now very much a buyer’s market and five year mortgage rates are at a historical low.
It is however, the opinion of more than just a few that the recent moves designed to crack down on what has been described as reckless real estate speculation may have swung the regulatory pendulum just a wee bit too far. Out here on the West Coast we are also dealing with the effects of the recent imposition of harmonized sales tax and a provincial government that is suffering from a financial budget hangover of Olympic proportions.
Making it harder for first time buyers to qualify for mortgages and increasing the required down payment for investors purchasing rental properties have contributed to a cooling of the real estate market. Perhaps, by its recent actions, the Bank of Canada may have pulled a rabbit out of the hat, thereby reducing a need for future interest rate hikes in the short term. We are truly living in interesting times.
Paul E. Croy
Lending Yourself Your Own RRSP Money
Some years back, while working as a Branch Manager for a Canadian Trust Company, I was given an opportunity to gain experience in the area of using your own RRSP to fund a “Non Arm’s Length” Mortgage. Proceeding to then give several seminars on the topic, I went a long way to establish myself as somewhat of a local expert. Recently however, while having coffee with a close friend, it came to my attention that to this date the general public still knows very little about what is required in order to lend your own RRSP funds as a mortgage. Over coffee, my friend claimed that he had just finished a long discussion with a client who was 100% convinced, after listening to a local radio talk show, that he could borrow from his RRSP without being required to even have the funds in his RRSP. Something had been definitely lost in translation.
Just to set the record straight, yes, you have to have the funds in your RRSP in order to fund the mortgage. What you will also find out is that due to the “Non Arm’s Length” relationship between the Mortgagee (your RRSP) and the Mortgagor (yourself), the mortgage will have to be insured by Canada Mortgage & Housing Corporation in order to become a qualified asset for your RRSP to hold. The main focus of all the administrative rules and conditions that apply is to insure that both you and your RRSP are not gaining an advantage or being put at a disadvantage when compared to rates and terms available in the “open mortgage market”. In addition, your RRSP funds would have to be transferred to a self directed RRSP (SDRRSP) account administrated by a Trustee who is an approved National Housing Act lender and who is also willing to administrate this type of RRSP asset. You will quickly find that not every SDRRSP Trustee wants to undertake the task of administrating this type of asset.
When doing your research you will soon become very aware of the many costs and fees. There are one-time set up costs plus ongoing annual SDRRSP Trustee administrative fees. For some clients, once a careful review of the costs is done, lending RRSP funds to yourself can make sense. Prior to 1984, it was commonly thought that Canadians could not use their RRSP funds for such a transaction. In 1984, a tax lawyer based in Toronto obtained a tax ruling establishing that, provided a mortgage met the strict lending guidelines established for an RRSP “Non Arm’s Length” transaction, it could qualify as an asset held in a SDRRSP plan.
Based on my calculations and due to the many costs and fees involved, I found that it was important to have a minimum mortgage amount of at least $50,000.00 available in your RRSP plus a minimum of a 6 – 7 year time horizon before even considering any economic or emotional benefits that might be derived from lending yourself your own RRSP money. The first SDRRSP funded mortgage that I helped set up was in 1984 for a client who was an accountant. Years later, I had the opportunity to ask this client if, in his opinion, it had been worth all the effort and expense. After a long pause, his answer was simply, “It sure just felt good to be paying myself”.
Paul E. Croy
Should I Purchase Mortgage Life Insurance?
I recently read an article by Talbot Boggs of the Canadian Press (June 30, 2010). Though I agreed with most points made in the article, I disagree with the suggestion that a borrower should purchase mortgage insurance as an option if offered by the lender.
Firstly, the mortgage balance will be declining but the insurance premium will remain consistent, hence over time, the borrower will be receiving less. Secondly, if you decide to port (move) your mortgage to another lender when the term is up, the insurance will not be transferable.
I propose that if a borrower wishes to have the additional security offered by insurance (and I totally agree) then an insurance policy outside of the mortgage contract should be considered. This insurance can be a fixed term or whole life policy.
There are several advantages to this strategy:
Firstly, the policy is with the borrower and stays with the borrower no matter who holds the mortgage.
Secondly, the borrower can pick an amount that is appropriate to their situation. He or she does not have to purchase an amount to pay off the full mortgage.
Thirdly, the amount of payout from the “life” insurance remains consistent.
Finally, and probably most importantly, in the event of the demise (death) of the borrower, cash from the policy will go to the beneficiary. The beneficiary, who often is the spouse, will have money to make mortgage payments, pay utility bills, buy food, etc. for the family while they get their life adjusted to the new situation.
It makes no sense to have a debt free house if the hydro, water, gas and telephone are disconnected. This is a morbid subject, but it needs to be considered by all borrowers.
P.S. Be sure to obtain competitive quotes from a few life insurance agents before committing.
Jeffery Moses
