Risks Of 5 Year Fixed Mortgages

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.

How To Beat 2.99% 5 Year Mortgage Rate

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:

Summary:

• 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.

2 Factors That Can Affect Your Home Value

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.

1/ Interest Rate 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.

Why Ultra Low Mortgage Rates Are Not Good?

We have experienced low mortgage rates since the financial credit crisis in late 2008.  The purpose of the low rates is to stimulate consumer spending which will result in economic growth and recovery out of the recession.  In the last few weeks, there have been talks regarding the European debt crisis and how similar it looks like the 2008 credit crisis.  It started with Ireland and Greece, which are considered small economies in Europe. The credit crisis talks have shifted to Spain and Italy which are large economies.  As Germany and France continue to bailout their Euro zone counterparts, they accumulate more debt.  There were talks last week that France is in financial trouble which resulted in a stock market sell off among other bad economic news.  The bottom line there is a storm brewing in Europe which will come to fruition sooner or later.  This uncertainity has resulted in bond yields dropping to historic lows which will result in lower fixed mortgage rates.

There are now possibilities the Bank of Canada might hold or even consider cutting its benchmark rate (which sets prime rate) to stimulate the Canadian economy just in case Canada gets dragged into a slowdown due to what's happening in US & Europe.  This means continued low rates for the foreseeable future.

So What You Might Ask?

The concern with even lower interest rates, is creating more demand in the Canadian real estate market.  This is good news for first time home buyers since the affordability requirements will drop, however, more bidding wars might result (I can only comment on Toronto's real estate market since this is where I conduct my business) and some would lose out.  Canadian household debt is already at an all time high and taking on further debt could result in an unpleasant consequences for all (http://goo.gl/zzcDH).  The lower rates will pull the future demand into the present and leave a void in the future.  The other concern is Canadians getting used to these low mortgage rates and not plan for higher interest rate environment when mortgages renew in a few years from now.

Finally, taking on debt with a responsible plan to pay if off can be a good thing. However, taking on debt and not planning for higher interest environment will have dire consequences.

To discuss your personal mortgage financing situation, please contact me.

Are Mortgage Interest Rates Dropping?

My Commentary On What The Bank Of Canada Said Today

Where Is Prime Rate Going?

Why Fixed Rates Move So Much?

Are You Ready For 6%?

Today's mortgage rates remain to be extremely low due to the uncertainity in the global market (risk of Greece defaulting), anemic job creation in the US and massive government debts and deficits.  In Canada, we have been lucky not to experience the pain of our neighbours to the south or across the pond in Europe. Fixed mortgage interest rates are hovering in the mid to high 3% which are historically low.  Over the last 25 years, fixed rates average around 6% (see chart below which shows posted rates. Typically, there is 1.5% difference between posted and discounted)

It is important to budget ahead for the time when mortgages are up for renewal at the 6% level. Inflation hedge strategy, is a pro-active plan where the mortgage is reviewed annually and adjusted according to the projected renewal rate.  This strategy saves the borrower thousands of interest dollars and accelerates paying down the mortgage principal.  At renewal, the borrower's mortgage balance is reduced and adjusted for higher interest rate environment eliminating any payment shock.

For variable mortgage holders, the savings are even greater, since the mortgage is paid at the fixed interest rate level which contributes more monies towards paying down the mortgage principal.

For your personal mortgage review and inflation hedge analysis, please contact me.

Is That The Best Rate You Have?

In today's competitive mortgage market, there is lots of "lowest interest rate" and "best mortgage rates" advertising in the media. I even saw a jeweler offering mortgages!!  Is the best rate really what's best for one's situation?

Asking for and making a decision strictly on lowest rate is similar to someone walking into a financial planner's office and asking for the lowest MER mutual fund.  Mortgages are investments and need to be chosen based on where the economy is currently, what's expected to happen with interest rates over the next few years (inflation, job creation and global factors), personal and financial situation and borrower's risk tolerance. The fine print of the mortgage such as compounding, prepayment priviliges, increased payments, portability, assumability and how the penalty is calculated are important features to be understood upfront prior to commiting to a mortgage product.  It's unfortunate that homeonwers have been programmed to get the lowest rate, set the payment and not look at the mortgage till renewal time. There are significant opportunities in optimizing the mortgage to reduce the amortization and build significant equity in a shorter period of time if the mortgage is managed properly by a professional.

The next time you are in the market for a mortgage whether you are buying a home or an investment property, renewing, or refinancing, please email me to send you a checklist of factors to consider in choosing what's right for you and your family.

Please contact me should you have any questions regarding your mortgage.

What Drives Variable Rate Mortgages?

My previous blog post discussed factors driving fixed rate mortgages.  What about variable rate mortgages? Variable mortgages are driven by prime rate (which is based on Bank of Canada's benchmark rate) and the discount a lender would provide. For example, 5 year variable mortgage at prime less 0.75%.

The benchmark rate, is set by the Bank of Canada on eight set dates annually.  Bank of Canada targets inflation around the 2% level, if inflation is higher then the benchmark rate is increased to control inflation and in cases where there is low inflation (or deflation), the benchmark rate is lowered to stimulate consumer spending and business investments due to the low cost of borrowing.

What does the dollar have to do with prime rate?

Canada's benchmark rate cannot be at a much higher level than the US benchmark rate since a substantial difference between the two would drive foreign investors to buy the Canadian dollar and appreciate its value.  A stronger Canadian dollar would reduce Canada's competitiveness by making Canadian products more expensive therefore reducing exports and slowing economic growth.  The US economy has and will continue to experience tough and slow economic recovery. The US Federal Reserve will keep its benchmark rate low to stimulate the economy, create jobs, promote consumer spending and increase housing demand through low interest rate environment.  With the upcoming US elections in 2012, the US will keep rates low to aid re-electing the current president (historic data shows in re-election years US interest rates are kept low).  This low US interest rate environment will exert more pressure on the Bank of Canada not to increase the Canadian benchmark rate aggressively till the end of 2012 which makes variable interest rates favourable. Having said that, the Bank of Canada will have to increase the benchmark rate to control inflation and high consumer debt levels, however it will be gradual. My prediction is 0.5% increase for this year.

For your personal mortgage review, please contact me.

What Drives Fixed Rate Mortgages?

Since January of this year, fixed rate mortgages have been volatile (see chart below) with many increases followed by decreases whereas prime rate (which affects variable mortgages) has been stable over the same period of time. What drives fixed interest rates to be this volatile?

Fixed rates are driven by the bond market.  Bond yields decrease with bad news such as the recent Japanese natural disaster and the Libyan crisis. These events which occured in mid March resulted in lower fixed rates for a short period of time. On the other hand, news such as higher inflation and positive job creation drive up bond yields since investors move their money into the stock market and for bonds to be attractive for investors, they would have to provide a higher yield (ie. fixed rates would increase).

Good economic news with respect to job creation, lower number of Canadians filing for unemployment insurance, US economoy creating jobs and trimming its deficit, result in increased bond yields and therefore higher fixed rates.

In my opinion, the number one risk over the next few years as the global economy recovers is inflation. Governments spent billions of dollars to stimulate the economy by providing liquidity into the market which has to be paid for by the taxpayers eventually.  High inflation would drive up fixed rates accordingly.

To review your personal mortgage situation, please contact me.

Why Everyone Should Have A Re-Advanceable Mortgage?

What's a re-advanceable mortgage? Typically, homeowners get a mortgage on their home or investment property and should they need to access their home equity for investment or personal reasons, they would have to break the mortgage, pay a penalty and legal fees to refinance their mortgage.  A great way to continuously access their equity, homeowners can get a re-advanceable mortgage.

The homeowner will need to have 20% equity in their home.  Based on qualifications, a mortgage up to 80% of the appraised value can be obtained and split into a fixed or variable mortgage with a line of credit.  As the homeowner pays down the mortgage principal, the line of credit increases by the principal amount for a total of 80%. This product can be obtained on primary residence and one rental property.

Example

Home value: $400,000

80% mortgage: $320,000

Mortgage portion: $300,000, line of credit portion: $20,000

As the mortgage principal is reduced, eg. $319,500, the line of credit increases to $20,500.  Another benefit of this product is the homeowner does not pay interest on the line of credit until funds are borrowed which allows the homeower to aggressively paydown their mortgage knowing that all the available principal would be accessed via the line of credit.

For your personalized mortgage review, please contact me.

How To Position Your Mortgage Today?

We have heard the governor of Bank of Canada, Mr. Carney, over the last few weeks talk about high level of Canadians household debts and his concern of homeowners getting used to the low rate environment. The concern as the global economy recovers (especially US & Europe), there will be a rate "snap back" to normal levels where homeowners would experience a payment shock.

Here are facts to consider:

• US Federal reserve prime lending rate is between 0% and 0.25% and will continue at these levels until unemployment numbers improve and GDP growth accelerates. In my opinion, these rates will stay around this level well into the next presidential elections in November 2012.
• Bank of Canada prime lending rate is at 1% and the bank is reluctant to have a large difference with the US Fed rate since international investors would buy the Canadian dollar which would increase its value, slowing down exports and negatively affecting Canada's economy.

Taking the above into consideration, prime rate would probably be at the same level or slightly higher until the early part of 2012.  This favours a short term variable mortgage where the borrower would benefit from the lower rate and the borrower can negotiate a new product in 2.5 to 3 years based on the economic conditions where possibly bigger discounts to the prime might be available.  An important factor to take into consideration is to set the variable mortgage as one is paying for a fixed mortgage, where the difference in payment pays down the principal reducing total amortization and saving thousands of interest dollars.

Finally, it is important to make a decision based on your personal financial situation since cash flow for a first time home buyer is different from a self employed homeowner which is different from a family with 2 kids who are in daycare.

For information about inflation hedge strategy and how to position your mortgage, please contact me.