With fixed mortgage rates rising quickly in the last few weeks, is it finally time to lock in your variable mortgage?
Another self inflicted US crisis is underway; the US Government has shutdown as of October 1, 2013 and overnight 800,000 Americans have lost their jobs. To put this in perspective, imagine the whole population of Mississauga and Oakville being unemployed overnight!
Canada's Prime Rate Impact
How does this chaos affect Canada's mortgage rates?
- US Federal Reserve is committed to its bond buying stimulus program till unemployment is at 6.5%. Currently, unemployment in the US is at 7.3% and with 800,000 Americans losing their jobs and the ripple effect of small businesses that do business with the US Government, the unemployment rate will increase if the shutdown is prolonged hence would force the US Federal Reserve to maintain its stimulus program and ultra low benchmark rate (prime rate)
- Bank of Canada's second in command, Tiff Macklem, said this week the Bank of Canada is lowering its outlook for Canadian GDP for this year and 2014
- August's core inflation was at 1.3%, well below Bank of Canada's target of 2%
- Bank of Canada's benchmark rate cannot deviate far off US Federal Reserve benchmark rate since it would result in a higher Canadian dollar which negatively affects exports, i.e, bad for the economy
With the prospect of the benchmark rate (prime rate) holding steady for one to two years, the case for variable mortgages is stronger today. There are two catches however:
- Applicant has to qualify based on the posted 5 year rate, which is at 5.34% today.
- If US Government defaults mid October, we all remember what happened in 2008 when the financial market seized and costs of borrowing spiked since no one was willing to lend money (supply of money disappeared overnight), cost of borrowing would increase.
If you are looking for professional mortgage advice based on facts, numbers and detailed analysis, please contact Nawar.
There has been lots of talk about interest rates not moving up for the next year or two. But mortgage rates are up already! There are two types of mortgage products: fixed rate and variable rate. Variable mortgages are based off prime rate which is set by Bank of Canada's benchmark rate, whereas fixed mortgages are based off bond yields. As per the Bank of Canada's most recent announcement, the benchmark mark rate remained unchanged which effectively left all variable mortgages, HELOCs and unsecured lines of credit unchanged. However, the bond market has experienced a sharp increase in yields which pushed fixed mortgage rates higher.
Variable Mortgage Rates
Bank of Canada's benchmark rate is a tool to control inflation around the 2% level. As inflation creeps up, the Bank of Canada increases its benchmark rate to slow down spending due to the higher costs of borrowing. On the other hand, when the economy contracts (recession), the Bank of Canada reduces its benchmark rate to stimulate spending and economic growth. Currently, Canada is in a stable inflationary period, therefore the prime rate has not changed for a few years and should remain close to the 3% level in the near future.
Fixed Mortgage Rates
You might be wondering, why did fixed mortgage rates move while prime rate did not?
The bond market movements are influenced by good or bad economic news. Good economic news result in money moving from the bond market, which offers low returns since it is considered a secure investment, into the stock market for higher returns. For the bond market to be attractive for investors, yields increase. As yields increase, fixed mortgage rates increase. Good economic news such as job creation, GDP growth, improved housing numbers result in upward pressure on bond yields and fixed interest rates. The US economy has been showing signs of improvement which caused the recent increase in fixed mortgage rates.
There you have it, now you know why fixed mortgage rates have increased and variable mortgages have not.
With the recent 5 year mortgage rates increase, the difference between 5 year and 10 year fixed mortgages is at an all time low, is it time to rethink the 10 year fixed mortgage strategy?
As expected, the Bank of Canada rate left its benchmark rate unchanged at 1% on December 4, 2012. Here are 2 things you need to know from the Bank of Canada rate announcement:
US economy grew gradually but is held back by the looming fiscal cliff which could push it back into a recession dragging Canada with it. China's economy is soft landing which is a good thing for Canada's resource economy (oil & minerals) whereas Europe is in recession. The global economic situation is negative which puts less pressure on increasing interest rates in the near future.
Canada's economy grew below expectations in the third quarter, housing market is cooling and household credit has slowed. The Canadian dollar continues to be strong and inflation is as expected. These indicators point to a slowing economy and the lack of need to raise interest rates in the near future.
The surprising statement was:"Over time, some modest withdrawal of monetary policy stimulus will likely be required". Based on the current economic situation around the world and Canada, there doesn't seem to be any requirement to increase interest rates, if anything, additional stimulus might be required.
For now, enjoy the variable mortgages and take advantage of the decreasing fixed mortgage rates.
As of November 1, 2012, OSFI (Office of Superintendent of Financial Institutions) requires lenders to qualify conventional and insured variable mortgages using Bank of Canada's benchmark rate. Will this lead to the end of variable mortgages? Prior to November 1, 2012, all insured mortgages were required to qualify based on Bank of Canada's benchmark rate. The new rules will restrict Canadians' ability to qualify for conventional variable mortgages and conventional shorter term (1-4 year) mortgages.
Here is an example:
Annual Income: $100,000 Mortgage Amount: $450,000 (assuming 20% downpayment) Annual Property Tax: $4,500 Annual Heating: $1,200 Monthly Car Lease & Personal Debt: $750
Prior to the new mortgage rules, the borrowers would have qualified for a variable mortgage using a 3 year rate which have put the GDS/TDS ratios at 28.67/37.67. As of November 1, 2012, the GDS/TDS is 35.3/44.29 since the Bank of Canada benchmark rate (currently 5.24%) is used to qualify.
Is This The End Of Variable Mortgages?
As you can see, the borrowers will be forced to take a fixed mortgage for 5 year term or longer since they can't qualify for a variable mortgage. My issue with the new mortgage rules is how will anyone qualify for a variable mortgage or fixed mortgage of 1-4 year term when the benchmark rate is at 7-8% as rates normalize in the future? Having borrowers lock into longer terms than they need to might result in paying IRD (interest rate differential) penalty to get out of the mortgage which can be exorbitant.
The solution to this issue is putting more downpayment if possible to get the mortgage qualification ratios in line.
To discuss your downpayment options and how to qualify for short term fixed mortgage or variable mortgage, please contact me.
The US Federal Reserve announced on September 13, 2012 that it will embark on a third round of stimulus (QE3) to improve the employment numbers in the US. What does this announcement have to do with Canadian mortgage rates? Mr. Carney, the governor of the Bank of Canada, has to keep the benchmark rate which sets prime rate relatively close the US Federal Reserve benchmark rate, otherwise the Canadian dollar would appreciate and have downward pressure on Canadian exports due to the higher cost of Canadian goods. This would be bad for the Canadian economy and force the Bank of Canada to hold its benchmark rate at or close to its current level to late 2015 along with its US counterpart.
If you are variable mortgage holder who has a prime minus mortgage, this announcement is great news since prime would probably not move dramatically in the next while. However, the risk is as central bankers "print" money to stimulate the economy, inflation will become an issue sometime in the future. The message here is to take advantage of your current variable mortgage but plan and prepare for the future.
As a mortgage professional who enjoys numerical analyses and economic discussions, I have had numerous conversations with financial planners, colleagues and clients of mine regarding the direction of interest rates in the future. What's happening in Europe? What if Greece pulls out of the Euro zone? Impact of US dollar on Canadian dollar? Inflation? Mr. Carney and Mr. Flaherty warnings regarding increased household debt?
The above video captures the compelling argument that now more then ever is a golden opportunity to lock into a 10 year fixed mortgage.
I really hope that as many people as possible see this post. I think there is a small window of opportunity since rates may rise at anytime. Please share this post via social media. Afterall knowledge is power and making decisions based on data is powerful.
Please feel free to contact me to discuss your questions or comments regarding the 10 year mortgage.
Variable mortgages up to late summer of 2011 were very attractive due to the large discount off prime at that time (prime less 0.75%). Many homeowners and real estate investors took advantage of getting a variable mortgage on their home or real estate investment properties. The mortgage product is portable and assumable which means the homeowner or real estate investor can port (transfer) the mortgage to a new home as long they qualify and it's done within a certain period of time between selling one property and buying another (typically 90 to 120 days). As for being assumable, the mortgage can be taken over by the buyer should they qualify. There is a catch however when porting a variable mortgage. Unless the exact mortgage amount is transferred over to the new property, lenders will reset the rate to whatever the market rate is at that time. Here is an example, let's say the borrower got a variable mortgage at prime-0.75% and the balance at the time of moving is $250,000. They are buying a home which will require the mortgage amount to increase to $300,000. The borrower can consider 2 options:
- Port the mortgage of $250,000 and obtain a line of credit for the difference, in this case $50,000 in order to maintain the prime-0.75% on the variable mortgage
- Obtain a new $300,000 variable mortgage at today's rates (prime-0.1% to prime+0.1%) with the same lender without incurring a penalty
In the above case, it's clear that keeping the mortgage at prime-0.75% is a wise option. It's important to understand the fine print of the mortgage and and discuss the available options with your mortgage professional.
As for the blog post title, yes variable mortgages are portable, but with a catch!
To discuss your personal mortgage financing situation, please contact me.
Over the last month or so, I have heard some mortgage brokers promoting the 4 year fixed rates to their clients since it coincides with the US presidential cycle based on the argument that in US election years, mortgage rates remain low for the incumbent President to be re-elected. As a mortgage broker who is driven by data and facts, I had to do some research to justify these statements. Before we dive into data, let's understand what drives mortgage rates:
- Fixed rates are driven by the bond market which moves up and down based on economic news. Good news drive the bond yields higher, therefore increasing rates and vice versa; bad economic news drive the bond yields lower therefore reducing fixed mortgage rates.
- Variable mortgages are driven by prime rate which is set by the Bank of Canada (independent of government) and the discounts on prime are driven by liquidity and credit risk factors. In good times, variable mortgages were at prime-0.8%, during the financial meltdown of late 2008, variable mortgages were at prime+1%
Bank of Montreal's 2 week promotion of 2.99% 5 year fixed rate has initiated a flood of emails from lenders lowering their interest rates on various mortgage terms. Yes, the gloves are off since we are back from the holidays and the real estate market is active again. Can this rate be beat? The answer is yes if one looks at a longer term. Here is a scenario I ran for clients today based on a $250,000 mortgage:
Option 1: 10 year fixed 3.89% amortized over 30 years.
Option 2: 2.99% 5 year fixed amortized over 25 years, renew at normal interest environment of 5.75% for 5 years (click here for historical chart).
For both options, the monthly payments are set exactly the same over the 10 year period. Here is a screen print of the comparison chart:
- Option 1 home equity after 10 years: $75,706 (10 year fixed results in additional equity)
- Option 2 home equity after 10 years: $69,576
- Payment shock with option 2: $310 per month when renewing from 2.99% to 5.75%
- With inflation hedge mortgage strategy, additional equity would be obtained with option 1
In conclusion, mortgage rate is important, however looking at the long term picture and minimizing the cost of homeownership is key.
To discuss how you can be mortgage free sooner, please contact me.
A new year is upon us and we are hearing the same things: "Real estate is overvalued by 10%, 25%...", "We are due for a correction".... I agree that real estate prices, and I'll only speak for Toronto since this is where I live and conduct my business, have appreciated over the last few years, however, one can't generalize since real estate is very local. As per my previous posts "2 Factors That Can Affect Your Home Value", interest rates spike or unemployment spike are the 2 factors that can derail real estate prices. The other factor, is some major global disaster such as a country defaulting on its debt, would affect everyone and everywhere.There is lots of information on TV, radio, newspaper and on the internet. It can be overwhelming and paralyzing.
I am a firm believer in putting a plan together and taking action. Since it's early in the year, it's a great time to put a financial plan (when you want to be mortgage free or think about buying an investment property to create long term wealth or topping up your RRSPs or consolidating debt to improve cash flow) then take action. It's best to look back at year end and be grateful for taking action this year as opposed to wishing had done something 12 months earlier.
Please feel free to contact me to discuss your personal mortgage and financial goals.
When buying a home with 5% downpayment, the mortgage has to be insured per Government requirement. The insurance premium is 2.75% (for 25 year amortization) or 2.95% (for 30 year amortization) which equates to the homeowner having 2.25% to 2.05% equity in their home at the day of closing. In the first few years of homeownership, the majority of the mortgage payment pays for the interest portion and minimal mortgage principal is paid down. It's important to keep in mind that if one is planning to move in 5 years (outgrow the 1 bedroom condo), once the costs (realtor fees, legal fees, downpayment requirement for new home & closing costs) are taken into account, the seller might find themselves to be short of funds which will mean they have to stay for a longer period of time in their current home.
It's important to have a plan to paydown the mortgage principal which fits a person's long term goals. Afterall, getting a mortgage, setting the payment and forgetting about it is not a sound approach to financial freedom.
To discuss your personal mortgage financing needs, please contact me.
The word "referendum" was used again this week!
Toronto and GTA's real estate values have increased significantly over the last 10 years. The prices continue to increase as the global economy struggles to emerge out of the slowdown since late 2008. There are 2 factors that can negatively affect the housing market in Toronto, GTA as well as Canada: Interest rate and/or unemployment spike.
For the last 3 years, Canadian homeownerns and real estate investors have enjoyed historically low interest rates which have resulted in record sales and prices. Interest rates have remained low to stimulate consumer spending and promote GDP growth. As Canadians reach record debt levels (approximately $1.50 of debt to $1 earned), Canadians are running out of steam for further debt accumulation. Many Canadians have fixed mortgages in the 3.3%-3.8% and variable mortgages at the prime minus level.
In order to save the global economy from a depression, governments around the world took on aggressive stimulus (printing money) since late 2008 which will result in high inflation sometime in the future. As inflation becomes the primary objective of governments, interest rates will have to rise to control and moderate inflation. Canada is already experiencing high inflation numbers, however the Bank of Canada is choosing to keep its benchmark rate low due to the uncertainty originating out of Europe.
A spike in interest rates would effect Canadians since mortgages will renew at higher interest rates and unsecured loans would cost more. Based on August 2011 data, the affordability index in Toronto for 2 storey homes and bungalows is at 61.4% and 51.9% respectively (http://goo.gl/8rK5B). If one assumes that an income earner is taxed at 40%, it means that in order to buy a 2 storey or bungalow in Toronto, 2 incomes are required. Condos are a more affordable option in Toronto at 34.2%.
A spike in interest rates which diminish the ability of many to qualify for a mortgage especially insured since qualification is based on posted rates. Demand would therefore be reduced since less buyers can qualify for a mortgage.
The main point to take away from this post is to have a plan regarding mortgage/debt paydown and plan to renew ones mortgage at a 6% level. For more information, click here.
My next post will discuss unemployment spike.