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
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
“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
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
Interest Rates on the Rise?
The Bank of Canada has signaled that they do not expect to hold present interest rate levels past the end of June…..
See the March 11, 2010, Business Week article, Canada January New Home Prices Rise 0.4%, Seventh Straight Gain
We are presently enjoying the lowest interest rates seen since the Korean War, and the only thing we can absolutely count on is that rates will inevitably rise. The ‘experts’ cannot seem to agree on when or by how much, but the varied opinions range upwards to an increase of 2.0% – 2.5% by the end of 2011.
I believe that now is the time to become pro-active and ensure that you take advantage of the present interest rate environment. Do you wish to explore the possibility of ‘renegotiating’ an existing mortgage? Would you like to ‘lock-in’ an interest rate for an upcoming purchase? Does your mortgage ‘mature’ in the next few months? Fixed rate vs. variable rate?
Our mortgage professionals are your best source for mortgage advice and can explain all your available options.
Walt Neufeld
Changes to Lending Guidelines for Insured Products
Jim Flaherty, Canada’s Minister of Finance, announced new lending guidelines for Canadian Mortgage and Housing Corporation (CMHC) backed mortgage loans in a recent announcement.
The new rules are as follows:
1. All borrowers must qualify for a mortgage using the five year fixed rate regardless of the term chosen.
2. When refinancing a home, Canadians will only be able to refinance up to 90% of the value instead of the previous 95%.
3. If you want to purchase revenue property CMHC will no longer insure you. You’ll need to put 20% down to take out a conventional mortgage.
These changes will take effect April 19, 2010.
What does this mean to the consumer who is presently trying to qualify for the maximum mortgage amount? I would recommend putting your plans in motion for purchase or refinance before the rapidly approaching deadline.
See the Government of Canada Department of Finance website for more details
Chris Pahl
Interesting Times for Canadian Mortgage Borrowers
Those of us who have been working in the mortgage industry for more than just a few years will agree that these are most interesting times. Borrowers who took advantage of variable rate mortgage offerings a few years back are now confronted with the hard question, “Do I look at locking into a fixed longer term mortgage or do I continue to “float” at a deeply discounted interest rate?” The one thing that I have learned about this business is that there is nothing more constant than change. Rates go up and rates go down. Rate volatility can happen for many reasons and some times not for the reasons a borrower expects, like a tight supply of mortgage funds or a Financial Institution’s Fund Matching requirements.
I agree that there are many economic reasons not to expect large increases in Canadian Mortgage Interest rates in the near future. However, based on the Bank of Canada’s position calling for an increase to the prime rate starting this summer, current mortgage underwriting guidelines that get less flexible every day, plus a recent trend that shows an increase in the 5 to 10 year Canadian Government Bond Rates, it may now be time to take a hard, honest look at the affordability issue of mortgage payments.
If interest rate were to jump 1%, 2% or 3%, would you still be comfortable with your shelter costs? Always remember that we are dealing with historically low mortgage interest rates. Some lenders offer the option of a split mortgage term. This permits a mortgagor to leave a portion of their mortgage floating while at the same time locking in a portion at a fixed longer term. This may well be a product that borrowers will start to embrace as a prudent option over the coming months.
Paul Croy
Balance in the Canadian Housing Market?
There was an interesting article written by The Canadian Press (posted February 17, 2010) regarding the Canadian real estate market. Victoria, Vancouver Island & BC are different ‘cups of tea’, but I certainly think that our market IS becoming more balanced and that anticipated, and coming, changes in ‘qualification criteria’ for ‘insured’ mortgages will actually assist in stabilizing our market.
The HST will certainly impact sales of homes priced at the mid – high end of our marketplace, but should not slow ‘entry level’ sales. Entry level sales inevitably drive the rest of the market so….. I am cautiously optimistic regarding our real estate market!
My thoughts on when / how higher interest rates will affect us is another matter… for another day.
TGIF… Go Canada!
Walt
