Anyone caught off-guard by mortgage rate hikes by five of Canada’s banks during the last week of March probably wasn’t paying attention to the bond market – and, let’s face it, that means most people.
A common misperception is that mortgage rates follow the Bank of Canada’s overnight lending rate. While it’s certainly true that we’ve seen historical lows in both over the last few months, the central bank only affects variable mortgage rates. Fixed-rate mortgages are affected by government bond yields, which have been trending upward for the past six weeks.
The reason? Bond traders are expecting the Bank of Canada to either raise rates sooner than the planned date of July 20 or be more aggressive in raising them than previously anticipated. Typically, the bond market moves two to four months before the Bank of Canada does.
“The bond market is a live market that can change and fluctuate constantly, but they typically move in anticipation of events, not the events themselves,” says Peter Kinch, a Vancouver-based broker. “It’s almost like a speculative market.”
Another reason behind the increase, says Benjamin Tal, senior economist at CIBC World Markets, is that U.S. government bond yields are rising and that often impacts Canada’s bond yields. “Long-term rates in the U.S. are going up primarily because of the fact that people are becoming concerned about the ability of Obama to fund the debt,” says Mr. Tal. “Unfortunately, you and I are paying for Obama’s healthcare program in a way.”
That won’t make anyone looking for a mortgage feel better. Almost all the major banks boosted their five-year mortgage rates by 60 basis points to 5.85%. Mortgage rates generally rise at a one-to-one ratio with bond yields, says Tal, and the benchmark five-year government bond yield on March 29 was 2.9%, up about 50 points since Feb. 8 and a 17-month high.
Banks like the difference between the five-year bond yield and their best — not the posted — five-year mortgage rate to be between 90 and 110, says Mr. Kinch (although others suggest the spread is 125 to above 135. That spread is the profit between what banks can secure money at and what they can sell it at in the form of mortgages.
Mr. Kinch says it’s not necessary to understand the intricacies of how bond markets work to figure out where mortgage rates are heading, just pay attention to patterns in yield changes, which are readily available online. When the spread between bond and mortgage rates goes too high, banks bring their rates down, and when the spread dips, they increase them. Since 1980 there has been a 97% correlation between the two rates on a monthly basis.
“The spread was either getting too close to 90 or may have slipped below 90, and since they were anticipating a further increase in bond yields, they priced in a 60-basis point increase to give them a buffer and create a bigger spread,” says Mr. Kinch. “If they were wrong in their predictions, they will adjust them next week.”
Mr. Kinch believes a 25-point rise in the overnight lending rate, maybe as soon as April 20, is more likely than something dramatic. That would give Bank of Canada governor Mark Carney a chance to assess any fallout before raising the rate again. However, if it looks like he’ll stand pat, bond yields will likely come down, followed by mortgage rates.
Even though bond yields change almost every day, mortgage rates don’t because that would cause consumer confusion. “Banks will move when they feel the increase is not a one-off thing,” says Mr. Tal. “They don’t want to drive everyone crazy with changing mortgage rates.”
Banks are also more likely to respond quickly to rising bond yields than they are to dropping yields, according to a Bank of Canada study in 2009 called Price Movements in the Canadian Residential Mortgage Market. That’s partly because banks generally offer 60 to 120-day rate guarantees and early payment options, both of which cost the lender if rates rise.
There are exceptions, especially if banks sweeten the pot to buy customers with lower rates. For example, bond yields on March 9 went up, but mortgage rates at RBC and BMO actually fell.
Those days would seem to be over for now, but there could be 20- to 30-point dips in mortgage rates even as they generally rise, says Mr. Kinch. “You’d be foolish to expect rates to go back down again,” he says. “The rates we saw last week, I’d be surprised if we see those again maybe in our lifetime.”
Mr. Kinch was advising people to lock into low five-year rates earlier in March after noticing the steady rise in bond yields, but notes that rates are still near historic lows. Jittery first-time homebuyers looking for security should take a fixed five-year mortgage, but consumers comfortable with a variable mortgage can find rates at less than 2%. However, Mr. Kinch recommends boosting the monthly payment to a level that would be similar to a 5% fixed rate. That accelerates debt repayment and helps adjust for higher rates down the road.
Wednesday, April 7, 2010
Tuesday, April 6, 2010
Variable mortgages (almost) always win
Whether They're Taking On New Mortgages Or Renewing Ones They've Held For Years, Homeowners End Up Asking Themselves The Same Question: Should They Lock In Their Mortgage Or Should They Let It Float With A Variable Rate. Here, Toronto-Based Wealth Manager Scott Tomenson Makes The Case For Variable.
ARE VARIABLE MORTGAGES AS GOOD AS THEY LOOK?
Q: My fiance and I have just bought our first home and we are going in circles about what is the best mortgage for us before we close. We currently have a locked-infixed rate with a bank of 3.98%, which we prefer to the uncertainty of taking a variable mortgage. But would we be better off with a variable-rate mortgage, especially if we saved money during periods when rate are low and use that to make payments on principal? Will that offset costs when our payments are higher than our current fixed rate?
Getting Dizzy, Ontario
A: Historically, as far as interest rates are concerned, it is better to float your mortgage interest rate (i. e., choose a variable rate mortgage). This is a result of the "yield curve." The "normal" yield curve is positively sloped, with interest rates lower for short-term maturities (one to two years) and higher for longer-term maturities (five to 30 years). When the economy strengthens, the Bank of Canada will raise short-term interest rates (they only have control over short-term rates) and the base for variable-rate mortgages (usually the prime rate) is moved higher. This action signals a period of "tightening" of monetary policy to cool the economy and reduces inflationary pressures.
The vehicles that determine longer-term interest rates -- bonds -- tend to move according to inflationary expectations: If bond investors anticipate inflation (because of economic growth), they demand higher returns (interest rates) as protection from inflation. When the Bank of Canada is perceived as "fighting" inflation by raising shortterm interest rates, long-term rates have a tendency, in most cases, to remain stable or improve, because long-term bond investors are content that inflation will not grow.
In essence, while short-term interest rates may go up, they do so only until the Bank of Canada has slowed the economy enough to curb anticipated inflation. Then, as economic growth slows, the bank starts to lower them. The yield curve will flatten (with higher short-term interest rates) for a time, but when the economy slows, short-term rates will go back down and the yield curve returns to its "normal" positive slope.
Over this time, variable-rate mortgages will move up to being approximately equal to locked-in five-or 10-year rates, but that's followed by a period when they return to lower levels. More often than not, over this time, it is less costly to have held the variable rate debt. Exceptions to this situation would be times of hyper-inflation (like in the 1980s) when short-term interest rates went to extreme levels.
If you had a variable mortgage at prime minus over the past few years, as I did, it's been a great ride. I kept my payments level and the low interest rates allowed to me to pay off massive amounts of principal. True, the economy is strengthening and shortterm rates will go up a bit over the next couple of years, but I don't think it will be dramatic. The case for variable-rate mortgages remains strong.
ARE VARIABLE MORTGAGES AS GOOD AS THEY LOOK?
Q: My fiance and I have just bought our first home and we are going in circles about what is the best mortgage for us before we close. We currently have a locked-infixed rate with a bank of 3.98%, which we prefer to the uncertainty of taking a variable mortgage. But would we be better off with a variable-rate mortgage, especially if we saved money during periods when rate are low and use that to make payments on principal? Will that offset costs when our payments are higher than our current fixed rate?
Getting Dizzy, Ontario
A: Historically, as far as interest rates are concerned, it is better to float your mortgage interest rate (i. e., choose a variable rate mortgage). This is a result of the "yield curve." The "normal" yield curve is positively sloped, with interest rates lower for short-term maturities (one to two years) and higher for longer-term maturities (five to 30 years). When the economy strengthens, the Bank of Canada will raise short-term interest rates (they only have control over short-term rates) and the base for variable-rate mortgages (usually the prime rate) is moved higher. This action signals a period of "tightening" of monetary policy to cool the economy and reduces inflationary pressures.
The vehicles that determine longer-term interest rates -- bonds -- tend to move according to inflationary expectations: If bond investors anticipate inflation (because of economic growth), they demand higher returns (interest rates) as protection from inflation. When the Bank of Canada is perceived as "fighting" inflation by raising shortterm interest rates, long-term rates have a tendency, in most cases, to remain stable or improve, because long-term bond investors are content that inflation will not grow.
In essence, while short-term interest rates may go up, they do so only until the Bank of Canada has slowed the economy enough to curb anticipated inflation. Then, as economic growth slows, the bank starts to lower them. The yield curve will flatten (with higher short-term interest rates) for a time, but when the economy slows, short-term rates will go back down and the yield curve returns to its "normal" positive slope.
Over this time, variable-rate mortgages will move up to being approximately equal to locked-in five-or 10-year rates, but that's followed by a period when they return to lower levels. More often than not, over this time, it is less costly to have held the variable rate debt. Exceptions to this situation would be times of hyper-inflation (like in the 1980s) when short-term interest rates went to extreme levels.
If you had a variable mortgage at prime minus over the past few years, as I did, it's been a great ride. I kept my payments level and the low interest rates allowed to me to pay off massive amounts of principal. True, the economy is strengthening and shortterm rates will go up a bit over the next couple of years, but I don't think it will be dramatic. The case for variable-rate mortgages remains strong.
Monday, April 5, 2010
Mortgage loophole helps first-timers
There is a small loophole in the new federal mortgage rules that could make it easier for the banks to lend out money to first-time buyers.
The federal government announced last month new requirements for anyone borrowing money for a house and needing mortgage insurance. If you have less than a 20% down payment and are borrowing from a financial institution covered by the Bank Act, you have to take out mortgage default insurance, which ensures the banks are covered for any losses resulting from payment defaults.
For principal residences, the new rules force consumers to qualify for a loan based on being able to make payments on a five-year fixed-rate mortgage, which has a much higher interest rate than variable mortgages, now as low 1.85%.
Clearly, Ottawa’s view was toward rising rates. And this week, two of the major banks raised their posted rate on five-year fixed mortgages to 5.85%.
But one lingering question is how the five-year rate would be calculated in terms of qualifying a customer. In other words, it would obviously be a lot tougher to qualify for a mortgage under the new rules when using the posted rate of 5.85%. But if using the actual rate consumers get -- these days as low as 3.75% -- that’s a lot less income you’ll need to buy your first home.
Officials in Ottawa have been mum on what numbers should be used.
But an internal document distributed by Canada Mortgage and Housing Corp. to mortgage brokers, obtained by the Financial Post, shows consumers will be able to use their actual rate to qualify for a mortgage if they go for a term five years or longer.
If buyers want a variable-rate mortgage, they will have to qualify based on “the benchmark rate,” which is essentially the posted rate.
So, if you want to go short, you had better be able to make payments based on an interest rate as high as 5.85%, which is where the benchmark rate will likely sit by next week.
“Probably 10% of the overall mortgage population is going to be affected by this rule in the sense they are no longer going to be able to qualify for a variable-rate mortgage or a one- to four-year term,” says Robert McLister, editor of Canadian Mortgage Trends. “The qualifying rate is going to affect the debt ratios of those people.”
The end result may see more people forced to lock in their rate, which is hardly fair given variable-rate mortgages have been a better deal than fixed-rate rate mortgages about 88% of the time over the past 50 years, before the recent credit crisis.
“This will help people become accustomed to making payments based on where mortgage payments are likely to be going,” said Peter Vukanovich, chief executive of Genworth Financial Canada, the mortgage insurer.
He doesn’t think the changes are a major deal, given that most of the major banks have been qualifying consumers based on their four- and five-year rates. His company was already only insuring products based on rates as high as 4%.
“It’s a good rule change when you are situation right now where we are increasing interest rates,” says Jim Smith, vice-president of Scotia Mortgage Authority. “Most lenders, ourselves included, have qualified based on at least the three-year posted rate.”
The discrepancy is, the three-year posted rate at most banks is actually higher than the five-year discounted rate.
And that means it is actually going to get easier to get a mortgage -- as long as you do what the government tells you to do and lock in your rate.
The federal government announced last month new requirements for anyone borrowing money for a house and needing mortgage insurance. If you have less than a 20% down payment and are borrowing from a financial institution covered by the Bank Act, you have to take out mortgage default insurance, which ensures the banks are covered for any losses resulting from payment defaults.
For principal residences, the new rules force consumers to qualify for a loan based on being able to make payments on a five-year fixed-rate mortgage, which has a much higher interest rate than variable mortgages, now as low 1.85%.
Clearly, Ottawa’s view was toward rising rates. And this week, two of the major banks raised their posted rate on five-year fixed mortgages to 5.85%.
But one lingering question is how the five-year rate would be calculated in terms of qualifying a customer. In other words, it would obviously be a lot tougher to qualify for a mortgage under the new rules when using the posted rate of 5.85%. But if using the actual rate consumers get -- these days as low as 3.75% -- that’s a lot less income you’ll need to buy your first home.
Officials in Ottawa have been mum on what numbers should be used.
But an internal document distributed by Canada Mortgage and Housing Corp. to mortgage brokers, obtained by the Financial Post, shows consumers will be able to use their actual rate to qualify for a mortgage if they go for a term five years or longer.
If buyers want a variable-rate mortgage, they will have to qualify based on “the benchmark rate,” which is essentially the posted rate.
So, if you want to go short, you had better be able to make payments based on an interest rate as high as 5.85%, which is where the benchmark rate will likely sit by next week.
“Probably 10% of the overall mortgage population is going to be affected by this rule in the sense they are no longer going to be able to qualify for a variable-rate mortgage or a one- to four-year term,” says Robert McLister, editor of Canadian Mortgage Trends. “The qualifying rate is going to affect the debt ratios of those people.”
The end result may see more people forced to lock in their rate, which is hardly fair given variable-rate mortgages have been a better deal than fixed-rate rate mortgages about 88% of the time over the past 50 years, before the recent credit crisis.
“This will help people become accustomed to making payments based on where mortgage payments are likely to be going,” said Peter Vukanovich, chief executive of Genworth Financial Canada, the mortgage insurer.
He doesn’t think the changes are a major deal, given that most of the major banks have been qualifying consumers based on their four- and five-year rates. His company was already only insuring products based on rates as high as 4%.
“It’s a good rule change when you are situation right now where we are increasing interest rates,” says Jim Smith, vice-president of Scotia Mortgage Authority. “Most lenders, ourselves included, have qualified based on at least the three-year posted rate.”
The discrepancy is, the three-year posted rate at most banks is actually higher than the five-year discounted rate.
And that means it is actually going to get easier to get a mortgage -- as long as you do what the government tells you to do and lock in your rate.
Friday, April 2, 2010
Mortgage-rate rise means borrowers' party is almost over
Increase creates a dilemma for prospective homebuyers
Without announcing last call, Canadian banks have taken the punch bowl away from the mortgage party that millions have enjoyed, and hangovers are looming.
Last summer, the Bank of Canada and Federal Reserve in the United States said their overnight lending interest rates would remain near zero until at least the middle of this year. The reaction by Canadians was to buy houses with rates at historic lows, and party on.
But as economies in North America began rebounding, central banks hinted rate increases could occur fairly soon, especially in Canada.
Bond rates rose in anticipation and that was the catalyst for banks to lift five-year mortgage interest rates, generally by 0.6 per cent -- the greatest single-day hike since 1994 -- to 5.85 per cent. That's an increase of $88 in monthly payments on a $250,000 mortgage for 25 years.
And they've only just begun. The C.D. Howe Institute think-tank suggests the Bank of Canada should raise its overnight rate by 1.75 per cent in the next year, likely lifting five-year mortgage rates to 7.0 per cent, while other economists envision a five-year rate as high as 8.25 per cent in two years.
That presents a dilemma for prospective homebuyers. Should they join an anticipated rush to purchase homes now and lock in at low rates, although housing prices could climb immediately with a blip in buyers during this period? Or should they wait for the frenzy to die down, expecting house prices to be lower in 12 months than they will be in three, even though mortgage rates will be higher a year down the line?
A major consideration should be whether you think you can handle lower mortgage rates now in this recovering economy better or worse than you would be able to handle higher payments a year from now when the economy, we hope, has improved and the employment situation has stabilized somewhat.
The Conference Board of Canada released a report saying one-fifth of Canadians already cannot afford both good-quality housing and either nutritious food or healthy recreational activity.
And the Bank of Canada reported that if mortgage and consumer credit interest rates went up one per cent, a record-high 9.6 per cent of households would be deemed financially vulnerable.
The question is whether we will pass the tipping point from people being unable to get into the housing market to the state where existing homeowners are unable to keep the roofs over their heads. You don't need long memories to recall how prolonged low interest rates after the 2001 terrorist attacks in the United States eventually led to massive foreclosures there when homeowners couldn't afford payments once rates rose.
Finance Prof. Moshe Milevsky with York University in Toronto says that instead of just considering financial savings in whether to have a short-term variable or long-term fixed mortgage, a person should also consider debating whether going with a short-term mortgage will leave a person unable to qualify for renewal, say if they lose their job, at variable and short-term rates.
Adrian Mastracci, with KCM Wealth Management in Vancouver, says: "If you can stand the inevitability of higher payments, a variable rate can still make sense.
"But those that have no wiggle room on increased payments should look at a five-year rate."
He also suggests paying down lines of credit aggressively before rates climb, investigating the penalty to refinance your mortgage at a lower rate if possible, considering a mortgage that is partly fixed and partly variable, and shopping around and negotiating for the best rates.
With rates so low, financial institutions had little wiggle room to offer valued clients lower-than-posted mortgage rates, but that expands as posted rates go up.
And that segues into one of the three mortgage changes the federal government brings into force later this month. In the past, borrowers had to make enough family income to pay the three-year fixed mortgage rate to qualify for a mortgage, and the new rules mean you will have to earn enough family income to handle the five-year fixed rate. TD Bank said a person wanting a mortgage on a $337,000 home would need to make another $9,200 in household income to qualify. It will be more than that with the higher five-year rates.
But one question has been whether the qualifying standard would be based on the posted five-year-fixed rate, or on an actual reduced rate a borrower might get. A document by the Canada Mortgage and Housing Corp. suggests the lower actual rate would be used.
Even so, it is suggested some people wanting to lock in long-term may no longer qualify for a variable-rate mortgage or a term of less than five years.
On the positive side of rising interest charges, a widening spread between borrowing and lending rates means bank shares should do well and they may be able to increase dividends.
And for investors who turned to safety amid the volatility of equity markets in recent years, rising rates should start to improve returns on vehicles like guaranteed investment certificates and money market funds and high-interest bank accounts.
For borrowers, the party's almost over, but for many lenders it's only just begun.
Without announcing last call, Canadian banks have taken the punch bowl away from the mortgage party that millions have enjoyed, and hangovers are looming.
Last summer, the Bank of Canada and Federal Reserve in the United States said their overnight lending interest rates would remain near zero until at least the middle of this year. The reaction by Canadians was to buy houses with rates at historic lows, and party on.
But as economies in North America began rebounding, central banks hinted rate increases could occur fairly soon, especially in Canada.
Bond rates rose in anticipation and that was the catalyst for banks to lift five-year mortgage interest rates, generally by 0.6 per cent -- the greatest single-day hike since 1994 -- to 5.85 per cent. That's an increase of $88 in monthly payments on a $250,000 mortgage for 25 years.
And they've only just begun. The C.D. Howe Institute think-tank suggests the Bank of Canada should raise its overnight rate by 1.75 per cent in the next year, likely lifting five-year mortgage rates to 7.0 per cent, while other economists envision a five-year rate as high as 8.25 per cent in two years.
That presents a dilemma for prospective homebuyers. Should they join an anticipated rush to purchase homes now and lock in at low rates, although housing prices could climb immediately with a blip in buyers during this period? Or should they wait for the frenzy to die down, expecting house prices to be lower in 12 months than they will be in three, even though mortgage rates will be higher a year down the line?
A major consideration should be whether you think you can handle lower mortgage rates now in this recovering economy better or worse than you would be able to handle higher payments a year from now when the economy, we hope, has improved and the employment situation has stabilized somewhat.
The Conference Board of Canada released a report saying one-fifth of Canadians already cannot afford both good-quality housing and either nutritious food or healthy recreational activity.
And the Bank of Canada reported that if mortgage and consumer credit interest rates went up one per cent, a record-high 9.6 per cent of households would be deemed financially vulnerable.
The question is whether we will pass the tipping point from people being unable to get into the housing market to the state where existing homeowners are unable to keep the roofs over their heads. You don't need long memories to recall how prolonged low interest rates after the 2001 terrorist attacks in the United States eventually led to massive foreclosures there when homeowners couldn't afford payments once rates rose.
Finance Prof. Moshe Milevsky with York University in Toronto says that instead of just considering financial savings in whether to have a short-term variable or long-term fixed mortgage, a person should also consider debating whether going with a short-term mortgage will leave a person unable to qualify for renewal, say if they lose their job, at variable and short-term rates.
Adrian Mastracci, with KCM Wealth Management in Vancouver, says: "If you can stand the inevitability of higher payments, a variable rate can still make sense.
"But those that have no wiggle room on increased payments should look at a five-year rate."
He also suggests paying down lines of credit aggressively before rates climb, investigating the penalty to refinance your mortgage at a lower rate if possible, considering a mortgage that is partly fixed and partly variable, and shopping around and negotiating for the best rates.
With rates so low, financial institutions had little wiggle room to offer valued clients lower-than-posted mortgage rates, but that expands as posted rates go up.
And that segues into one of the three mortgage changes the federal government brings into force later this month. In the past, borrowers had to make enough family income to pay the three-year fixed mortgage rate to qualify for a mortgage, and the new rules mean you will have to earn enough family income to handle the five-year fixed rate. TD Bank said a person wanting a mortgage on a $337,000 home would need to make another $9,200 in household income to qualify. It will be more than that with the higher five-year rates.
But one question has been whether the qualifying standard would be based on the posted five-year-fixed rate, or on an actual reduced rate a borrower might get. A document by the Canada Mortgage and Housing Corp. suggests the lower actual rate would be used.
Even so, it is suggested some people wanting to lock in long-term may no longer qualify for a variable-rate mortgage or a term of less than five years.
On the positive side of rising interest charges, a widening spread between borrowing and lending rates means bank shares should do well and they may be able to increase dividends.
And for investors who turned to safety amid the volatility of equity markets in recent years, rising rates should start to improve returns on vehicles like guaranteed investment certificates and money market funds and high-interest bank accounts.
For borrowers, the party's almost over, but for many lenders it's only just begun.
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