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
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
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
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
Baby Boomers & Old Age Pensions
The year 2011 will mark a milestone event. Next year will be the first year that members of a special demographic bulge in society, known as Baby Boomers, will start to turn age 65. At this age a person qualifies to receive Canada’s Old Age Security Pension. For years now this group of individuals, born between 1946 and 1964, has been studied as to the anticipated effect their aging will have upon our society.
Corporate North America has marketed to the anticipated wants and needs of Baby Boomers for decades. Why wouldn’t they? According to some statistics, Baby Boomers currently control over 80% of personal financial assets and represent about 50% of all discretionary spending. In general, this group loves to travel and enjoy life. However, it has been noted that many Baby Boomers have become complacent with regard to their personal debt levels. As retirement years approach, trying to balance current wants and needs against the debt servicing requirement for past financial excess might become a challenge for some Canadians.
These are the same challenges that our corporations and governments are currently facing. Today, both our federal and provincial governments are being forced to deal with past budgetary excess while simultaneously trying to find and fund policies that will lead to sustainable job creation. Meanwhile, corporate Canada is also dealing with their past years of over leverage and excess. In a recent luncheon speech, the Governor of the Bank of Canada pointed out that the “global recovery will not be smooth.” Retirement expectations for many have changed to include working longer, part-time retirement, or the addition of self-employed business income. During the years prior to your retirement it would be very prudent to take a hard look at your overall financial situation. For many clients this will involve seeking good independent financial council.
If you find that you are faced with the need to reduce excess personal debts, here are ten recommendations:
1. Always pay off your debt with the highest interest rate first.
2. Establish a realistic budget that allows for principal debt repayment.
3. Set both short and long term goals.
4. Review your progress regularly and reward your successes.
5. Make the application for debt restructure/consolidation while you are still employed not when you retire. The approval process will be much easier while you are working and have a higher income.
6. Consider refinance options. A refinance of your mortgage to consolidate high interest and/or unsecured debt can greatly lower your overall borrowing cost and improve your cash flow.
7. Give consideration to what your shelter needs truly are. Perhaps selling your current residence and buying a lesser valued property might place you in a much stronger financial position.
8. Do not consider selling your house or re-mortgaging to consolidate your debts until a careful cost benefit analysis is done.
9. Always remember that the payments you make on personal debt are being made with after-tax dollars. You have to first earn the money, pay taxes on it, and pay the interest due on your debt before you can see a principal reduction.
10. Most importantly, be truthful with yourself and your partner or spouse about your finances.
Paul E. Croy
“Much Ado About Nothing”
It’s been over a year of media focus on the potential end of historically low levels of Canadian interest rates. This week, it might be appropriate to quote the words of Mr. William Shakespeare, much ado about nothing, as the Bank of Canada recently decided to increase the Bank Rate by only 0.25%.
This increase was probably the single most anticipated and talked about increase ever witnessed in Canadian history. Many people originally anticipated a full half percentage increase, but recently almost every financial analyst expected the 0.25% increase that raised the prime rate at most Canadian banks to 2.5%.
Had Mark Carney, the Governor of the Bank of Canada, failed to raise rates this would have caused more of a concern as financial markets want certainty and predictability. After months and months of dealing with mortgage client’s concerns, this increase simply became a non-event. It was also very interesting to note that some mortgage lenders actually decreased their five-year mortgage rates shortly after the Bank of Canada rate announcement. Financial Institutions need to have certainty established in the long term trend of market interest rates before they can become truly competitive in their mortgage rate pricing.
In contrast to Mr. Shakespeare’s play, Much Ado About Nothing, which is a comedy, the Bank of Canada’s decision on interest rates is very serious business that effects a great cross section of our society. From small home based businesses to the construction industry and manufacturing firms, all feel the effects of the Bank’s Canadian Interest Rate Policy. Along with the value of our Canadian dollar, our Canadian family standard of living is affected too. The Bank of Canada is very aware of this fact as they attempt to balance the need to fight inflation while at the same time trying to grow our economy.
The bottom line looking forward is that we are going to see a slow and gradual increase in interest rates and this should not be a surprise to anyone. For clients still on floating rate mortgages, this may be a good opportunity to consider increasing your mortgage payment thereby accelerating your repayment and decreasing the amortization on your mortgage. This would also prepare you for slightly higher interest rates in the future while at the same time taking advantage of our still very low mortgage interest rates.
Paul E. Croy
Benefits of a Broker
Just like a travel agent, searching for the best fares, seat sales and connections to get you to your destination, a mortgage broker searches for the best interest rates and terms to complete your purchase transaction.
These are the benefits of using a mortgage broker:
- DISCUSS – I will discuss your mortgages needs with you and prepare your application for presentation to lenders.
- EXPLAIN – I will explain the mortgage approval process. I will obtain a mortgage commitment, lock-in the best rates and terms, and provide you with a pre-approval so you can confidently look for your new home.
- INFORM – I will inform you about the costs associated with arranging a mortgage. These may include: appraisal and survey fees, property transfer taxes, municipal tax adjustments, and, if applicable, CMHC premiums.
- RESEARCH – I will research the market for the best interest rates and terms available. This includes special discounts and rates, available only through mortgage brokers.
- PRESENT – I will present your application to the lenders most likely to approve your deal. I will highlight the strengths of your application in a manner that will be favorably viewed by lenders.
- NEGOTIATE – I will negotiate on your behalf. I work for you, not the lender.
- ADVISE – I will advise you about the terms, rates and details of each mortgage lender’s offer, in order to help you make the most suitable financing choice.
Financial institutions will only offer you their own mortgage product. A mortgage broker is able to mix and match different products from a variety of institutions in order to meet your particular mortgage requirements.
Financial Institutions offer lower rates, special discounts and a wider variety of mortgage products through mortgage brokers. Mortgage Brokers are a better way for banks and other major lenders to deliver their products to new customers and lower retail banking costs. The savings are then passed along to you.
Mortgage brokers are motivated to get the job done for you. We get paid only when you’re satisfied and your mortgage is funded. Last but not least, in the case of most residential mortgages, the lender/bank pays our fee.
Chris Pahl
A Shoe Short Story
My wife truly loves a good pair of shoes. Over the years she has built a fine collection of well over 100 shoes; I’m sure that there are much larger collections hidden away in other people’s home closets! The interesting point is that as much as she may love the look of shoes, her daily choice selection is normally based on comfort.
For most people, getting into a mortgage is much easier than getting out of it if they find that they have made the wrong choice. Making the wrong choice can be a source of stress with potentially large financial and emotional costs to be paid. The mortgage you select should be comfortable and flexible, fitting with your lifestyle expectations. It is very important that your mortgage leaves some financial room for you to still be able to enjoy the things in life that are important to you. Feeling ‘mortgage poor’ can be somewhat like being forced to walk a long distance in the wrong pair of shoes.
It is important to spend time up front looking at the economic realities of your cash flow prior signing your mortgage documents.
What I would recommend for many clients is to try living within a budget based on the proposed mortgage payment prior to committing to it.
Paul Croy
