Oil Prices and The Battle of Fixed vs Variable Mortgage

Your mortgage is up for renewal or you just bought a home and it is time to decide: fixed mortgage or variable mortgage.  Both options are at historic lows, which sounds like a broken record since the economic collapse of 2008. With 5 year fixed rates hovering around 2.89% and variable mortgages at prime less 0.6%, either option is attractive.  But how do you choose?The answer is in oil prices.

With oil prices collapsing from $140 per barrel to $45-$50 range in the last 6 months, Canada's GDP growth will slow down and there are talks of Alberta going into recession, yes the "R" word. Over the last 4 years, Alberta has been carrying the country with its economic growth. As Alberta slows down, inflation will be lower, unemployment will be higher (in Alberta, NewFoundLand and Saskatchewan).

Slower economic growth (GDP and employment) will lead to lower inflation, below 2-3% target range for the Bank of Canada which would keep prime rate at current levels.  If the economy shrinks, the Bank of Canada will cut prime rate to stimulate economic growth (as I write this post, the Bank of Canada has surprised the market by cutting the benchmark rate by 0.25%. Effective tomorrow, prime rate is 2.75%!)

Until the economy returns to "its full capacity" which the Bank of Canada is predicting to be late 2016, or later in my opinion, the benchmark rate which drives prime rate will probably not increase till then.

So, as oil prices go, so does the Canadian economy.

What Is Mortgage Increase And Blend?

Homeowners are taking advantage of historic low interest rates whether they are fixed, around 3%, or deeply discounted variables around prime less 0.5%.  Majority of homeowners and real estate investors choose a 5 year term, but what happens in the future if it is required to increase the mortgage amount for the purpose of debt consolidation, equity take out for investment purposes, or moving to a new home?

Home Equity Take Out Options

Example: Property value $480,000. Current mortgage balance is $250,000 at 3.09% with 3 years remaining till maturity and the homeowner wants to borrow $150,000 to buy an investment property.  There are 3 options for the homeowner to entertain:

1. Break the mortgage and restructure up to 80% based on current market value. Con: paying a penalty and refinancing at a higher interest rate (assuming interest rates will not be at 2.99% in 3 years time)
2. Add a HELOC up to 80% of current market value: HELOCs are offered at prime+0.5%. Good option since it is setup separately and interest costs can be easily tracked for income tax deductions
3. Increase & blend: Leaving the current mortgage at 3.09% unchanged, the homeowner can add another $150,000 to the mortgage based on current mortgage interest rates with the new mortgage maturing at the original date. In this case, a 3 year fixed term would the product choice.

The above illustrates the options for a fixed mortgage holder. The options are different for variable mortgage holders:

1. Refinancing the mortgage with the penalty being 3 month interest
2. Adding a HELOC up to 80% of current home value
3. Increase and blend is not an option lenders offer. To my knowledge only one lender allows increase and blend for variables. ING Direct used to allow it, however that might have changed after the acquisition by Scotiabank and renaming to Tangerine

One thing to look out for is the fine print detail for no frills mortgages (ultra low rates) as some might restrict the homeowners ability. For example, BMO's 2.99% offer allowed the homeowner to refinance only with BMO and did not allow adding a HELOC. Since the homeowner has no negotiating power they are at the mercy of the bank when it comes to interest rates.

There is more to mortgages than interest rates. Rates are the cost of getting into the mortgage, however the fine print can cost thousands more.

To navigate through the mortgage minefields and for a hassle free transparent experience please contact Nawar.

The Fine Print Of 2.99% Mortgage Rate

It is that time of year again....spring market. This is when the majority of real estate transactions occur and hence when the banks tend to get aggressive on mortgage pricing to gain market share.Another 2.99% offer was made by BMO which was in the headlines across various media outlets.  My objective in writing this article is to explain the fine print of BMO's mortgage. In 2014 homeowners ought to expect more transparency and explanation from their mortgage professional or bank employee.

Here are the fine print details of the 2.99% offer:

• 25 Years Maximum Amortization: It is advantageous to payoff your home early, however one size does not fit all.  If the homeowner, intends to buy an investment property, cottage or a second home in the future, the higher mortgage payment due to the lower amortization would restrict mortgage qualification. Other cases where 25 year amortization is disadvantageous are: self employed homeowner, family that's expecting a child and income will drop due to maternity leave, family that has to support a child through university, single parent,  homeowner who is looking to leave their job and start a business......
• Pre-Payment Privileges: 10%. Although the majority of lenders offer 15%-20% pre-payment privileges, I believe 10% is decent since majority of homeowners do not max out that privilege
• Increase Payment Privilege: 10%. Decent but again, not the best in the industry (15%-20%).
• Fully Closed Term: This is where BMO has their clients locked up. The homeowner can get out of the mortgage if they sell the home via bona fide sale (arms length sale) or refinances with BMO. In negotiations, if one has only option or entity to negotiate with they would not be in position to get a good deal.  The interest rate differential (IRD) for this mortgage product is punishing since it is 2% below the posted rate (4.99%) and it's equivalent to approximately 4% of the outstanding balance.

It is important for homeowners to sit with their mortgage professional and ask about the cost of getting into the mortgage (interest rate) and inquire about the costs of getting out of the mortgage (penalties, portability, restrictions).  A mortgage is one piece of the puzzle in a homeowner's financial plan and it is important to ensure the right product is chosen based on features and not just rates.

What Is The Mortgage Qualifying Rate (MQR)?

The mortgage qualifying rate is used to qualify all variable mortgages and fixed mortgages of 1-4 year term. The Bank of Canada updates the mortgage qualifying rate (MQR) every Monday at 12:01am.  5 year fixed or longer fixed terms qualify using the contract rate (the actual borrowing rate).  Here is an explanation:

Mortgage Qualifying Rate Example

Assumptions

• Household income: $100,000
• Assume 20% downpayment
• Freehold home, no condo fees
• 5 year fixed mortgage 3.19% amortized over 30 years
• 5 year variable mortgage at prime - 0.5% amortized over 30 years
• Mortgage qualifying rate (MQR): 4.99%

Maximum fixed mortgage: $577,000 (Purchase price: $721,250) Maximum variable mortgage: $466,000 (Purchase price: $582,500)

One way to increase the purchase power of a variable or fixed mortgage is obtain a 35 year amortized mortgage. Once the homeowner takes possession of the home, they can set the payment at the 30 year amortization level to avoid paying additional interest over the life of the mortgage.

To find out what you qualify for and a have a winning strategy for bidding wars, please contact Nawar.

CMHC Insurance Premium Increase

On February 28, 2014, CMHC announced mortgage insurance premium will increase effective May 1, 2014 for homeowners, self employed and 1-4 rental properties.Here is a chart of the current and new insurance premiums for owner occupied homes

What exactly does this increase translate into dollars and cents? Here is an example based on 5% downpayment, 3.49% mortgage amortized over 25 years

As you can see the increase is moderate ($8.98 per month) and should be manageable by homebuyers. It will be interesting to see what happens in the future since CMHC stated they will review insurance premiums annually and make announcements in the first quarter moving forward.

Genworth wasted no time in announcing similar increases to their premiums effective May 1, 2014.  Canada Guaranty took a few days to mull over their decision but they will increase their insurance premiums as well.

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