The Bank of Canada increased it’s interest rate this week. Is this good news, or bad news for real estate investors?
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.
There is never a dull moment in the Canadian mortgage landscape with new rules introduced by the Minister of Finance and OSFI, Office of Superintendent of Financial Institutions. I want to state upfront that I support these changes with the exception of reducing secured lines of credit (HELOCs) from 80% to 65% of home values. Canada's housing market has been very hot since the credit crunch of late 2008 and the house prices to income ratio gap has grown significantly due to stimulus low mortgage rates.I want to clarify what families will be facing in 2016, 2017 and beyond. Today's 5 year fixed rates are in the low 3's (3.09%-3.19%) which are fantastic. However, the extended period of low interest rates will be followed by periods of high interest rates due to the following:
- Focus will turn from stimulus in the global economy to combating inflation due to excessive stimulus (money printing and quantitative easing) since 2008
- Cost of borrowing will increase due the European credit crisis which will only intensify as Italy & Spain (3rd & 4th largest economies in Europe) deal with their debt issues. As you recall, in late 2008 when Lehman Brothers collapsed, money (capital) disappeared from the market, creating a supply issue and variable mortgages went from primes less 0.75% to prime plus 1% in a short period of time
I want to share the following numbers to help you see where I am going:
Family household income (pre-tax): $100,000 Income tax bracket: 45% Mortgage amount: $400,000 Interest rate: 3.09% Mortgage amortization: 30 years Monthly payment: $1912 Renewal Rate in 2017: 5.5% (an increase of 2-2.5% over 5 years is very reasonable based on historical data and the above stated issues) Mortgage payment at renewal: $2103 (increase of $416 per month)
Some would assume taking on an additional $416 per month in 5 years is doable. Let's dissect a little further:
In order to absorb $416 of additional mortgage payment, the family's pre-tax income has to increase by $9,000. That might sound reasonable , however, it's equivalent to getting 2.5% raise every year for the next 5 years. The economy is not in the greatest condition: not many companies are hiring, some are cutting back and the reality is keeping a job nowadays is great news. Furthermore, the increased cost of living (property taxes as municipalities deal with their debt and deficit issues, gasoline which affects goods prices, higher hydro rates....) will eat away into a family's affordability. I didn't mention that children cost more as they grow up!
This blog post is a reality check. We have been drunk for too long on cheap money. Plan for the long term and understand how future events should play into your decisions today. This is a golden opportunity to consider long term mortgages such as a 10 year fixed.
To get more information please visit: www.10YearFixedMortgages.com
Whether you agree or disagree with me, I would love to hear from you.
The Minister of Finance, Mr. Flaherty, announced today the following regarding insured mortgages which will take effect on July 9, 2012:
- Refinances will be limited to 80% of home value from 85%
- Maximum amortization will be lowered to 25 years from 30 years
- GDS limited to 39% (currently no GDS requirement for 680+ credit scores) and TDS to 44%
- Mortgages over $1 million will no longer be insured
Here is how these changes will impact the following groups:
First Time Buyers
- They will be squeezed out of the market if they don't have the 20% downpayment. Qualifying at 25 years, especially in Toronto, is difficult due to home prices in the city (condo fees are taken into account when qualifying for a mortgage as well)
- More potential first time home buyers will turn into longer term tenants which is good news for real estate investors
- Parents, get ready to co-sign for your children if they want to buy their first home
Real Estate Investors
- Since more first time buyers will have to wait for their first home, the tenant pool will increase. This is good news since more demand results in higher rental income
- Qualifying for additional investment properties should not change since government requires minimum 20% downpayment. This is pending conventional mortgage amortization is not lowered to 25 years. Please note there are lenders offering 35 year amortization for investment properties.
- If one has 20% equity or more in their home, 30 & 35 year amortized mortgages are available for now. The changes are not impacting this group, but we will have to wait and see if lenders will reduce mortgage amortization to 25 years
This announcement came out of nowhere and it surprised many. If this announcement is intended to cool off investors buying condos in downtown Toronto, I'm not sure it will achieve that since the changes are targeted towards insured mortgages only. Furthermore, this change gives the Bank of Canada room to hold its benchmark rate steady for a longer period of time due to a slowing global economy. I believe since the Bank of Canada's hands were tied, Minister of Finance came in to help control the high household debt level.
There will be more clarifications coming out in the next few days from the lenders which I will elaborate on. To discuss how these changes will impact your mortgage financing, please contact me.
Have rates ever been this low? With historic lows for the 5 year and 10 year terms, it is very enticing to take advantage of today's low interest environment. The question is whether one should go for 5 or 10 year. Before I answer the question, consider the following:
- US Federal Reserve stated its benchmark rate will remain at or near zero till the end of 2014
- Canadian household debts is at an all time high and will continue to increase since Bank of Canada has to remain close enough to the US Federal Reserve benchmark rate, otherwise the Canadian dollar will skyrocket negatively affecting exports in a sluggish global economy
- Governments around the world have been "stimulating", printing, money since late 2008 to get the global economies growing again which has lead to high government debts and deficits. Basically, governments are carrying the load until the private sector feels it is their time to start spending again.
- The European zone is in crisis and it is taking on huge amounts of debt by bailing out countries
These factors will eventually lead to inflation, but when will it happen? in 2015? 2016? 2020? No one really knows, but it will happen. In my opinion, the longer the rates remain superficially low, the more aggressive the increases will be to control inflation.
Homeowners who are taking on or renewing their mortgages in 2012 will renew in 2017 (if they take a 5yr term). Based on the fact the US Federal Reserve will keep its rate at or near zero and the Bank of Canada will stay relatively close till end of 2014, it is likely aggressive rate increases will commence in 2015 to control inflation and slow down Canadian household debt.
Today's 10 year fixed mortgage term is at an all time low and provides a good protection from economic and rate shocks. Consider this: would you take a 5 year fixed at 3.99% in 2017? What's the risk of a 10 year term one might ask? The mortgage is portable and assumable and the day after the 5 year anniversary, the penalty is based on 3 month interest NOT interest rate differential. I believe it is a great time to consider a long term safe mortgage strategy. To run your personal mortgage analysis comparing 5 year term versus 10 year term, please contact me.