Worthwhile Canadian Initiative

Canadian banks are typically leveraged at 18 to 1--compared with U.S. banks at 26 to 1.

Fareed Zakaria

NEWSWEEK

From the magazine issue dated Feb 16, 2009

The legendary editor of The New Republic, Michael Kinsley, once held a "Boring Headline Contest" and decided that the winner was "Worthwhile Canadian Initiative." Twenty-two years later, the magazine was rescued from its economic troubles by a Canadian media company, which should have taught us Americans to be a bit more humble. Now there is even more striking evidence of Canada's virtues. Guess which country, alone in the industrialized world, has not faced a single bank failure, calls for bailouts or government intervention in the financial or mortgage sectors. Yup, it's Canada. In 2008, the World Economic Forum ranked Canada's banking system the healthiest in the world. America's ranked 40th, Britain's 44th.

Canada has done more than survive this financial crisis. The country is positively thriving in it. Canadian banks are well capitalized and poised to take advantage of opportunities that American and European banks cannot seize. The Toronto Dominion Bank, for example, was the 15th-largest bank in North America one year ago. Now it is the fifth-largest. It hasn't grown in size; the others have all shrunk.

So what accounts for the genius of the Canadians? Common sense. Over the past 15 years, as the United States and Europe loosened regulations on their financial industries, the Canadians refused to follow suit, seeing the old rules as useful shock absorbers. Canadian banks are typically leveraged at 18 to 1—compared with U.S. banks at 26 to 1 and European banks at a frightening 61 to 1. Partly this reflects Canada's more risk-averse business culture, but it is also a product of old-fashioned rules on banking.

Canada has also been shielded from the worst aspects of this crisis because its housing prices have not fluctuated as wildly as those in the United States. Home prices are down 25 percent in the United States, but only half as much in Canada. Why? Well, the Canadian tax code does not provide the massive incentive for overconsumption that the U.S. code does: interest on your mortgage isn't deductible up north. In addition, home loans in the United States are "non-recourse," which basically means that if you go belly up on a bad mortgage, it's mostly the bank's problem. In Canada, it's yours. Ah, but you've heard American politicians wax eloquent on the need for these expensive programs—interest deductibility alone costs the federal government $100 billion a year—because they allow the average Joe to fulfill the American Dream of owning a home. Sixty-eight percent of Americans own their own homes. And the rate of Canadian homeownership? It's 68.4 percent.

Canada has been remarkably responsible over the past decade or so. It has had 12 years of budget surpluses, and can now spend money to fuel a recovery from a strong position. The government has restructured the national pension system, placing it on a firm fiscal footing, unlike our own insolvent Social Security. Its health-care system is cheaper than America's by far (accounting for 9.7 percent of GDP, versus 15.2 percent here), and yet does better on all major indexes. Life expectancy in Canada is 81 years, versus 78 in the United States; "healthy life expectancy" is 72 years, versus 69. American car companies have moved so many jobs to Canada to take advantage of lower health-care costs that since 2004, Ontario and not Michigan has been North America's largest car-producing region.

I could go on. The U.S. currently has a brain-dead immigration system. We issue a small number of work visas and green cards, turning away from our shores thousands of talented students who want to stay and work here. Canada, by contrast, has no limit on the number of skilled migrants who can move to the country. They can apply on their own for a Canadian Skilled Worker Visa, which allows them to become perfectly legal "permanent residents" in Canada—no need for a sponsoring employer, or even a job. Visas are awarded based on education level, work experience, age and language abilities. If a prospective immigrant earns 67 points out of 100 total (holding a Ph.D. is worth 25 points, for instance), he or she can become a full-time, legal resident of Canada.

Companies are noticing. In 2007 Microsoft, frustrated by its inability to hire foreign graduate students in the United States, decided to open a research center in Vancouver. The company's announcement noted that it would staff the center with "highly skilled people affected by immigration issues in the U.S." So the brightest Chinese and Indian software engineers are attracted to the United States, trained by American universities, then thrown out of the country and picked up by Canada—where most of them will work, innovate and pay taxes for the rest of their lives.

If President Obama is looking for smart government, there is much he, and all of us, could learn from our quiet—OK, sometimes boring—neighbor to the north. Meanwhile, in the councils of the financial world, Canada is pushing for new rules for financial institutions that would reflect its approach. This strikes me as, well, a worthwhile Canadian initiative

Renting vs Buying a House - The Great Debate

It’s the age-old debate. Do I rent or do I buy?

Renting

Paying rent is often the first step for someone after they leave their parents’ home. Whether it’s in a university dorm or a room in a house full of friends, most of us get our feet wet in the real world by paying somebody else for a place to live.

And there’s absolutely nothing wrong with that.

In fact, renting is a good way for people to live within their means, should they find a suitable place for the right price. Although it’s true you are paying, or helping to pay, somebody else’s mortgage, too many times people see this as the sole reason to buy their own home and become house poor in the process because there’s more to home ownership than mortgage payments.

By renting within your budget you avoid the ‘hidden expenses’ that come with home ownership, like higher refinancing mortgage rates, property taxes, and on-going upgrades and repairs. In some cities in Canada, renting is about the only option for people because of high housing prices in urban areas and their ever-expanding suburbs.

But renting does have its pitfalls. The saying is 100% true – you are paying someone else’s mortgage by renting their house or apartment. You also don’t build a credit rating by renting, nor do you have any say in the actions of your landlord/property owner, who could literally sell the house out from under you, leaving you in a tight spot and possibly in search of a place to live in a housing market that has skyrocketed since you were last on the market, throwing your budget for a loop.

If you are secure financially and have a higher standard of living than your average college student, you may want to explore home ownership, because there’s a chance you’re paying the same in rent as you would for a decent home in your neighbourhood.

Buying

Many people dream of owning their own home. Some rush into home ownership before they’re financially ready, although those days have probably come to end with the implosion of the ‘zero down’ mortgage, which gave many people a false security of thinking they could afford more house and therefore a bigger home loan because nothing was coming out of their pocket before they were handed the keys.

There are a lot of positives to home ownership that are fairly obvious – a secure place to live, a personal asset, a possible source of income whether through renting or resale – but a person must be prepared for the extra expenses like property taxes, repairs, etc., that are ever-present with home ownership. If you take on too much house – a mortgage your income can barely afford to pay – you run the risk of becoming house poor, and suddenly you’re living a life of much higher stress than somebody who is paying their rent each month and sleeping soundly every night. One financial hiccup – a broken furnace or the need to buy a new car – could put you over the top and in danger of not meeting your mortgage requirements.
It is important to budget accordingly for these costs when deciding how much you can spend on a home. The financial institution you choose will be able to help you with this.

Things to think about

Do you plan to move a lot in the future? If so, renting poses less risk than buying because you have nothing tying you down once your lease is up, if you even are required to sign one

Can you pass up these microscopic interest rates? The Bank of Canada, and the major lenders in turn, have cut interest rates in an attempt to spur homebuyers to take out mortgages. This February, the interest rate in Canada is a shocking 1%, down substantially from last February’s mark of 4%. Since 9/11, interest rates have stayed below 5% to stimulate spending, and the highest mark they’ve hit in the past decade was October, 2000, at 5.75%

How stable is your employment? Times are tough these days and most people could be downsized from their job at a moment’s notice. People without mortgages have much more flexibility because they can always reduce their monthly expenses by renting a smaller apartment, while people who own homes will have the same mortgage payment whether employed or not and will likely struggle to sell their home if it comes to that, during this economic downturn

Can you take advantage of a depressed market? The Canadian Real Estate Association said the number of houses sold through MLS in January, 2009, (16,343) was down a staggering 40.9% in January, 2008. As the economy continues to sputter, the more manufacturing jobs are lost, and the price of oil stays below $50 per barrel, the better the chance of much lower housing prices. People are going to need to sell, and if you’re in the position to buy, chances are good you’ll be able to capitalize on the buyer’s market

Are you over-extending yourself by buying? There are a lot of hidden costs aside from your mortgage – taxes, condo fees (where applicable), repairs – that may leave you ‘house poor’. Not only will this affect your way of life now, it could also hamper your ability to save for retirement. Renters have only two main housing expenses - rent and utilities

Home sales take enormous hit

B.C. real-estate prices dropped almost nine per cent from January 2008

The economic downturn delivered an enormous hit to B.C.'s housing market as the year began, figures released yesterday show.

Residential sales volume across the province tumbled 61.2 per cent to $873 million in January from the same month a year earlier, the B.C. Real Estate Association said.

B.C.'s average residential price dropped 8.9 per cent to $412,934 last month from a year ago.

And residential unit sales plunged 57.4 per cent in the same period, the association said.

"Home sales were sluggish in January, reflecting an overall malaise in consumer confidence and a weakening provincial economy," BCREA chief economist Cameron Muir said.

"Reports of an increasing number of consumers shopping for a home have yet to materialize in the sales statistics.

"The large selection of homes for sale in January likely reduced any sense of urgency for potential homebuyers to commit to a purchase."

Improving affordability triggered by lower mortgage rates and home prices should boost sales activity in the spring, the association said.

In Greater Vancouver, the average residential price fell 8.8 per cent year over year to $536,162.

Sales dollar volumes in Greater Vancouver fell 62.2 per cent year over year, while unit sales dropped 58.5 per cent during the same period, the association said.

In Victoria, year-over-year dollar volumes dropped 52.9 per cent and unit sales fell 44.7 per cent.

The average residential price in Victoria dropped 14.7 per cent to $431,312. The average residential price in Powell River posted the province's greatest drop, falling 23.4 per cent to $190,847.

New to Canada Mortgage Program

If you’ve ever lived abroad you know how difficult it is to get basic things that you take for granted in your own country such as a bank account, credit card, telephone services, etc. Over the last few years it’s become even more complex as there are now so many laws and regulations that are designed to prevent money laundering - it can be virtually impossible. Oftentimes, for those people who have recently arrived in Canada, it can be just as tricky to secure a mortgage in this country.

Thankfully, RBC is working with Genworth Financial and the Canadian Mortgage Housing Corporation (CMHC) to offer qualified homebuyers who have moved to Canada a mortgage with as little as a 5% payment and have outlined the steps and requirements below.

Approved mortgage types and properties

Acceptable home loan purposes for recent immigrants and people who have relocated to Canada are new home purchases, improvements and extended amortizations available up to 35 years.

There are a few restrictions on the type of properties that can be purchased such as a maximum of 2 units and one must be used as the principal residence, meaning you have to live in the property as your main home. It’s fairly flexible for the type of property you can buy as newly built houses and existing properties that are on the market are acceptable.

Loan-to-value ratio limits

The ‘Loan-to-value’ or LTV ratio as it’s commonly known is the amount of the property value less the down payment you can make over the property value. For example, if you were looking at a $100,000 property and had a $10,000 down payment (ie. $100K - $10K = $90K mortgage) the LTV would be 90% ($90K/$100K).

The maximum LTV ratio available to people new to Canada is currently 95%. 100% mortgages were available until October 2008 as the government stopped insuring $0 down payment mortgages in an effort to avoid a US style housing crisis and stop the so-called “sub-prime” mortgages from becoming a problem.

The table below outlines the LTV ratios and the insurance premiums you’ll have to pay to CMHC, the mortgage default insurer, on top of the loan for the mortgage default insurance which protects the lender in case the mortgage holder isn’t able to make the payments.

LTV ratio	Premium rate
Up to 65%	0.50%
65.01% - 75%	0.65%
75.01% - 80%	1.00%
80.01% - 85%	1.75%
85.01% - 90%	2.00%
90.01% - 95%	2.75%
* Please note the premiums are non-refundable

Qualifications required

The following qualifications are required for a mortgage:

• Maximum GDS/TDS: 32%
• Maximum GDS/TDS including heating payments: 40%

GDS ratio stands for the “gross debt service ratio” and is the percentage of the gross annual income that is needed to cover the mortgage payments. The total payment includes the mortgage principal, interest payable, taxes and can include other expenses such as heating and condo fees.

TDS ratio stand for the “total debt service ratio” and is the percentage of gross annual income that is needed to cover mortgage payments and all other debts such as car loans, personal loans, credit lines and credit cards.

In addition, you must have:

• Moved to Canada within the last 3 years (36 months)
• Had at least 3 months of full time employment in Canada - there is an exemption available if you have been transferred through your work
• Already have a valid work visa or have already received landed immigrant status
• All your international debts and obligations must be included in the TDS ratio
• Rental income on foreign properties can be excluded from the GDS/TDS calculation

Necessary documentation

You will need to supply the following documents to the mortgage lender:

• A valid work visa or verification of landed immigrant status

Depending on the LTV you’re looking at you’ll need:

• 95% LTV: an international credit bureau
• 90% LTV: A letter of reference from a recognized financial institution, or 6 months of historic bank statements with active account operations and no non-sufficient fund charges
• 85% LTV: if you’re getting a guarantor to help you with the process, then you will only need to show a valid work visa and the proof of landed immigrant status, otherwise, the same documentation is needed as per the 90% LTV

Credit and Down Payment Guidelines

Loan-To-Value Ratio (LTV)	Max LTV = 95%	Max LTV = 90%	Max LTV = 85%
Credit Requirements	International credit report proving a strong credit history	Reference letter from an internationally recognized financial institution or 6 months of historic bank statements from a primary account	If no credit references are available - a Canadian family guarantor with a strong credit profile is required
Down Payment	5% from own resources	10% from own resources 5% can come from a corporate relocation subsidy	15% from own resources Up to 10% can be a gift from the guarantor

Please note that this program is not available to any foreign Diplomats in Canada or any other foreign politically appointed individuals who don’t pay income tax in Canada.

Home listings withdraw as sales volume slows

The first month of 2009 saw a continued reduction in the number of homes listed for sale in Greater Vancouver, while sales volumes in January were the lowest for that month since the early 1980s.

The Real Estate Board of Greater Vancouver (REBGV) reports that sales of detached, attached and apartment properties declined 58.1 per cent in January 2009 to 762 from the 1,819 sales recorded in January 2008.

New listings for detached, attached and apartment properties declined 20.9 per cent to 3,700 in January 2009 compared to January 2008, when 4,675 new units were listed. Total active listings in Greater Vancouver currently sit at 13,966, down nearly 6,000 listings from October 2008.

Overall residential benchmark prices, as calculated by the MLSLink Housing Price Index®, declined 10.9 per cent to $489,007 between Januarys 2008 and 2009.

“Home sales and consumer confidence are at a low point at the moment, but the long-term strength and security of our housing market are beyond the reach of the economic clouds of today,” Dave Watt, REBGV president said.

“Today’s short-term conditions are creating long-term opportunities. Buying opportunities have not been this strong in a decade, with low interest rates, broad selection and more affordable prices,” Watt said.

Sales of detached properties declined 54.4 per cent to 292 from the 641 detached sales recorded during the same period in 2008. The benchmark price for detached properties declined 11.2 per cent to $659,638 in January 2009 compared to $742,490 January 2008.

Sales of apartment properties in January 2009 declined 58 per cent to 361, compared to 860 sales in January 2008. The benchmark price of an apartment property declined 11.6 per cent to $334,602 compared to $378,336 in January 2008.

Attached property sales in January 2009 were down 65.7 per cent to 109, compared with the 318 sales in January 2008. The benchmark price of an attached unit declined 8.1 per cent to $425,309 compared to $462,627 in January 2008.

Early Renewing Your Mortgage Term

With the recent decline in rates for fixed term mortgages, more and more home owners are looking to see whether it's worthwhile breaking their existing mortgage term. The upside for many home owners, depending upon what their goals are is that they can either lower their current mortgage payment for better cash flow or they can continue on with their existing payment and reduce their amortization. The prospect of saving thousands of dollars in interest is extremely appealing but there are a few factors that warrant careful consideration. Most borrowers understand that they will trigger an early prepayment penalty to get out of their current term. However, you should be aware that financial institutions calculate the penalty two ways and use the higher of the two amounts as the penalty. Most people are very familiar with the three month interest penalty which is merely the interest portion of your regular mortgage payment multiplied by three months. The other formula that the financial institutions use to calculate your penalty is the the interest rate differential (IRD). The IRD is the difference between the existing rate and the rate for the term remaining, multiplied by the principal outstanding and the balance of the term.

Example.

• $100,000 mortgage at 6.50% with 24 months remaining.
• Current 2 year rate is 4.0%.
• Differential is 2.5% per annum.
• IRD is $100,000 * 2 years * 2.5% p.a. = $5,000

The IRD is now coming into play for many fixed term mortgages because of how much the rates have dropped. I am finding that borrowers are extremely surprised by just how much their penalty is to break their existing mortgage term. Should interest rates continue to go even lower then that will translate into larger penalties. I still feel strongly that home owners should evaluate their current mortgage term and have a Mortgage Specialist calculate the benefits of early renewal. Many borrowers will still realize substantial savings over the course of the term by paying the penalty and locking in to the lower rates. The good news for those home owners who are in a variable mortgage is that the penalty is strictly three months interest.

Some financial institutions will allow you to include the penalty in your mortgage so that you are not required to pay it from your own resources. Any interest savings would then need to recalculated with the penalty amount added in to your outstanding mortgage balance. Other financial institutions will allow you to take cash back when you refinance in order to offset the penalty in part or in whole. Be aware though that while cash back sounds appealing, the interest rate will be increased accordingly by the amount of cash back you decide to take. The bottom line is that financial institutions are not going to offer these options if they are putting themselves in a worse off position. In fact, most of these options puts the financial institution in a better position because they will likely end up earning more interest from you in the long run.

One quick tip that can be a very effective in reducing your penalty is to pay down your annual allowable lump sum payment. Some financial institutions will automatically take it off when calculating the penalty while others will not. It's definitely worth asking your financial institution how they calculate the penalty prior to breaking the term. You should also be aware that some financial institutions only allow you to make the lump sum payment once a year(on the anniversary date) while others allow you to make one lump sum payment at any point during the year.

Another consideration that home owners should make when deciding to refinance is how it could possibly affect their insurance coverage. This is specifically for those borrowers who have taken the creditor insurance which went with the mortgage, in order to protect their families in the event of death, disability or critical illness. I strongly recommend that you find out what the implications are to your insurance coverage. Most creditor insurance premiums are based on the age of the borrower at the time of the initial application and remain in effect for the life of that mortgage. Not only could you potentially lose a very low insurance premium but you may have become uninsurable in the meantime and unable to qualify for any subsequent insurance.

Some of the more minor costs associated with early renewing but still applicable are the following. Legal costs($500) if switching to another financial institution or increasing the amount of the mortgage with your current provider. Appraisal costs($300) which may or may not be picked up by the financial insitution. Title Insurance($250+) if required by the lender. Transfer out fee($80-$200) charged by your current financial institution.

Variable versus Fixed Rate Mortgages

One of the most frequent questions I'm being asked is whether it makes sense to go with a variable rate mortgage over a fixed rate mortgage. Unfortunately there is no easy answer to this question because statistically speaking those who have chosen to go with the variable rate mortgage have been the beneficiaries more than 80% of the time. As we saw though in the latter half of 2007, the variable rate can move quickly and for those who were looking to lock-in to a fixed term, the rates had already gone up considerably. One of the key determinants I suggest in determining which one is best for my clients is their capacity to accept the interest rate risk and be able to afford a higher payment in the event that the rates go up. Fixed rate mortgages carry neither of these risks as the borrower knows their interest rate and their payment for the length of the term. Another factor for consideration is that clients must be more dilligent in monitoring rates both on the variable side and the fixed.
Economic factors will determine how long rates continue to remain at record lows as central banks around the world try to stimulate growth. There is no evidence to date that the global recession is turning around or even nearing a bottom. This bodes well for those who have chosen the variable rate mortgage as there seems little risk in the forseeable future that the Bank of Canada will start to increase rates any time soon. The caveat to this statement however is that given the flood of liquidity the Bank of Canada is pumping into the financial system, there will come a point at which the economy will gain traction and begin to turn around. Once this point is reached, the massive amount of money that the Bank of Canada has injected into the economy runs a serious risk of creating severe inflationary pressure. The only option for the Bank of Canada is to raise interest rates quickly and try to suck the excess liquidity out of the system. That is why borrowers who have chosen a variable rate mortgage will need to be extra dilligent in looking for signs of an economic recovery and be ready to act quickly to convert their mortgage to a fixed rate term.