Breaking up with your mortgage Variable rates look pretty attractive

Anybody who bought their first house in the 1980s must marvel at mortgage rates today. Or perhaps fume.

Another rate cut this past week from the Bank of Canada led all of the major banks to lower their prime lending rate to a new low of 2.5%.

Consumers who locked into variable-rate mortgages tied to prime before credit markets tanked are getting as much as 90 basis points below prime and borrowing as low as 1.6%. It's the deal of the century.

In October, the banks suddenly changed the rules on borrowing and demanded consumers pay a 100-basis premium over prime if they wanted to go variable. The banks have eased up since and the premium on a variable-rate product is 80 basis points above prime for a 3.3% rate.

It poses an obvious question for anyone who has locked into rates as high as 5.75% on a five-year fixed-rate mortgage: Should they break that mortgage?

"It probably does make sense to break it now," says Vince Gaetano, vice-president of Monster Mortgage.

He gives the example of one client who came into his office this past week with a $205,000 mortgage and a 5.24% interest rate. The customer had 3½ years left on a five-year mortgage. The penalty to break his mortgage is the greater of three months interest or what is called the interest rate differential. The interest rate differential is the lost interest between your current rate and market rates.

In that client's case, his interest rate penalty is calculated based on the current four-year rate at his bank, now 4.14% on a discounted basis. The lost interest to the bank is about $7,800, which is what the customer will have to pay.

It's a big penalty but Mr. Gaetano argues that if that same customer breaks his mortgage and goes with the variable-rate mortgage at 3.3%, the savings would be in the $13,000 to $14,000 range over 3½ years -- more than offsetting the penalty.

There is also a nifty little trick you can pull off if you have a prepayment option on your mortgage. Mr. Gaetano's customer has a 25% prepayment privilege, so he can knock $57,000 off his mortgage and lower his penalty by about $2,800.

"You can access [that 25%] from an unsecured line of credit or some credit cards for a few days and reduce your penalty because the penalty is based on the balance outstanding," says Mr. Gaetano.

While not encouraging people to break their mortgages, the banks are acknowledging that some consumers who locked into higher rates can save money if they refinance at the new lower rates.

"I think it does make sense as an option for some people trying to lower their rate," says Joan Dal Bianco, vice-president of real estate-secured lending at TD Canada Trust.

She says if you are refinancing your mortgage, you can take the interest rate differential penalty and tack it on to your new mortgage. If you have credit card debt, you can add that on too, and the refinancing makes even more sense.

The office of consumer affairs for the federal government has a great site to help you make the decision: www.ic.gc.ca/eic/site/oca-bc.nsf/ eng/ca01817.html. Moshe Milevsky, a professor at York University's Schulich School of Business, who created the calculator used on the government site, says it ultimately comes down to how much money you will save on your mortgage if you break the contract.

"To me, it's pure mathematics. There is nothing speculative or probabilistic about the decision to break a mortgage. It is the classic example of undergraduate finance time-value-of-money calculations. If the homeowner can refinance into a mortgage with an identical term that reduces monthly payments above and beyond any penalty costs, then go for it. Plain and simple," says Mr. Milevsky.

Breaking your mortgage based on a decision to go into a variable-rate mortgage is an entirely different decision.

"This decision shouldn't be confused or muddled with the classic long or short decision, or whether real estate prices or interest rates are headed up or down from here," he says.

So, it comes down to two choices: The first is to break your locked-in mortgage and renew for another fixed term. If it saves you cash, that is a no-brainer.

The second choice is whether to switch products and go with a variable-rate mortgage. Historically, consumers have saved money 88% of the time going variable, according to Mr. Milevsky's own studies.

I'm still in the camp that favours a variable rate.

Dusty Wallet This will not save you any money, but if you are strapped for cash because one of the breadwinners in your home has lost a job, the banks will let you lengthen your amortization period. If you have a 25-year amortization you can lengthen it to 35 years without any service charges -- other than the huge jump in interest charges!

Canada Prepared to Accelerate Asset Purchases to Help Economy

Canadian officials indicated they may broaden asset purchases to help lower borrowing costs and battle the effects a deepening global slump.

Bank of Canada Governor Mark Carney yesterday said purchases of non-government assets may be an option as the bank looks at policies beyond interest rate moves. In a separate interview, Finance Minister Jim Flaherty said he’s studying more efforts to shore up the commercial paper market.

“We have lots of options to look at,” Flaherty said in Horsham, England, on the sidelines of a meeting of finance ministers and central bankers from the Group of 20 “The key here is we’ll do what is necessary in order to make the markets function well in Canada.”

Canada’s economy shrank at a 3.4 percent annual pace in the fourth quarter, the most since 1991. Reports have also shown record job losses and trade deficits in recent months.

Carney signaled he’ll likely revise down his outlook for the world’s eighth-largest economy next month. The Bank of Canada’s forecast for 3.8 percent growth in 2010 is more than twice the pace predicted by the IMF.

“When we laid out the projections in the update in January, we also laid out some upside and downside risks,” Carney said in the interview. “It’s safe to say the downside risks, particularly around the outturn in the global economy, have materialized.”

Beyond Rates

Carney said purchasing non-government assets is an option the central bank may consider. Earlier this month the Bank of Canada cut its benchmark lending rate to a record low 0.5 percent, and said it is preparing to use policies beyond interest rate moves, if needed, to revive an economy hit by a recession and tight credit markets.

“As we bring out the framework, it will be consistent that the bank is managing credit easing or has a framework for managing credit easing and we’ll decide when and if to use it,” he said.

Credit conditions for corporations have tightened, with companies facing the worst prospects for obtaining loans or making new sales in a decade, according to a survey of executives by the Bank of Canada released Jan. 12.

Purchases of securities may help drive down longer-term interest rates, stimulating borrowing and economic growth.

Extraordinary Measures

Canadian policy makers left the door open for extraordinary measures earlier this month. The Bank of Canada said at its March 3 interest rate announcement that it will outline how it would implement such measures on April 23.

Fed Chairman Ben S. Bernanke has increased the central bank’s total assets by $1 trillion over the past year to revive the economy and stem the risk of deflation. In December, the Fed switched to using emergency credit programs as the main tool of monetary policy. The Bank of England this month began to acquire government bonds with newly created money.

So-called quantitative easing is designed to leave banks with so much cash that they stop hoarding and expand lending. It can involve a central bank buying securities and creating money to pay for them. A central bank can also try buying up securities to drive down longer-term interest rates, extending efforts to keep short-term rates low with benchmark rates.

Buying Assets

In Canada, the federal government has taken the lead in purchasing assets from the financial system in a bid to revive lending, including facilities to acquire as much as C$125 billion in mortgages from banks and C$12 billion in car loans and leases.

Carney said it’s logical for the government to purchase the mortgages through the state-owned Canada Mortgage and Housing Corp., rather than the central bank, because the agency already insured the assets. Still, the central bank has “providence” over “credit easing,” he said.

“It makes sense to run that through CMHC,” Carney said. “In terms of other potential measures, we’ll work with the government to decide how to design them.”

Flaherty said the finance department and the central bank are coordinating efforts.

“We both have a role. The key here is that the framework is a framework that matches what the bank can do with what the government can do,” Flaherty said. “I have regular discussions with the governor of the bank to make sure we don’t go off course, that what he proposes to do meshes with what the government is doing.”

Should you break your mortgage to save big bucks?

With interest rates plunging to their lowest levels in decades, many Canadian homeowners are eyeing the prospect of breaking their mortgages to negotiate new ones with more favourable rates.

Experts say that even with the financial penalties that come with breaking a fixed-rate mortgage, many homeowners may be in a position to save money by breaking with their monthly status quo.

Anthony De Almeida, president and CEO of CanEquity Mortgage, says interest rates have fallen so low in such a short period of time that last year's fixed-rate mortgages now seem "ridiculously high," even though they would be considered quite low historically.

Such dramatic changes in the market, these experts say, have sent homeowners marching to mortgage brokers to see if breaking their mortgage would be in their best interests.

To break or not to break?

Jim Tourloukis, president of Verico Advent Mortgage Services in Unionville, Ont., says the decision of whether or not to break one's mortgage can be made through simple mathematics.

"At the end of the day if the balance on their mortgage is less by breaking it, then it makes sense to do it," Tourloukis told CTV.ca in a phone interview.

Moshe Milevsky, a professor at York University's Schulich School of Business, said the key factor for homeowners is being in a position to absorb the financial penalty that comes with breaking a mortgage, but still coming out on top.

"It has to be someone that took out a mortgage at a relatively higher rate, maybe three years ago; it's got to be a relatively long amortization period so the interest clock is ticking at quite a high rate," he told CTV.ca in a recent phone interview. "For them this simple formula will work out."

"If it's only a couple of bucks a month, it may not be worth the hassle of going to the bank," he added. "But I would say if you can save $20 or $30 a month on the mortgage, why not spend an hour in the bank and go through the paperwork?"

The penalties

In general, the penalty for breaking a mortgage is either a payment of three months interest, or something called the interest rate differential (IRD) -- a non-standard calculation which seeks to compensate the bank for the money it loses when a homeowner breaks their mortgage.

"In theory what it represents is the interest cost, or the interest income, that the bank forgoes by you breaking the mortgage," said Tourloukis, of the IRD.

De Almeida describes the IRD as "the difference between the rate today and the rate that you have currently."

In any case, the bank charges homeowners the larger of the two penalties, which has tended to be the IRD as interest rates have plummeted.

Then there are legal fees, paid to lawyers who handle the cancellation of the old mortgage and the creation of the new one. De Almeida said these fees typically range between $500 and $1,000.

Once the combined penalties are calculated, they can be added to one's new mortgage balance or paid off directly depending on the homeowner's preference and financial means.

More security, less debt

Because interest rates are so very low right now, it may also be attractive for homeowners to negotiate new mortgages where they are locked-in at a fixed rate for the long term.

"The rates haven't been this low in 50 years or more, so anybody that's gotten a mortgage in the last three, four, five years is very interested in locking in," De Almeida said.

De Almeida said he has had many clients looking to lock in to seven or 10-year mortgages, even if it means paying more than they would for a shorter-term mortgage.

"Why not pay a little bit more and have 10 years of security, especially in this market?" he said.

In a similar way, homeowners can decrease their liabilities by opting to take other debt they may have -- say credit card or car loan payments -- and tack it on to their newly negotiated mortgage, in order to pay it off at better rates.

De Almeida said the combination of low interest rates and an otherwise tight credit market makes it "a perfect time to be throwing your credit cards into a mortgage and to becoming debt-free."

First-time buyers eye house bargains

If there is an upside to a recession, it's the inevitability that stuff gets cheaper.

Falling home prices may be hard on developers, but they can spark opportunity for first-time buyers – if the price is right.

According to figures released yesterday by Statistics Canada, Canadian new home prices declined by 0.8 per cent in January from the same month a year earlier, the first year-over-year decrease since January of 1997.

"Years of frenzied construction activity had left the market overdue for a correction," said Valerie Poulin, an economist with the Conference Board of Canada, in a report yesterday. "With demand for new homes waning across Canada due to poor economic conditions, the market drop off appears to be more severe than expected."

Declining housing starts will cut builders' profits by almost 20 per cent this year, to $3.2 billion, according to a report by the board. Residential construction industry growth is also expected to fall drastically, recording the biggest decline since 1995.

"Consumers are postponing expenses such as renovations or buying a home," the Conference Board said. "Tighter credit conditions are further dampening demand."

With prices falling, buyers in the existing home market can find detached homes for what some Toronto homeowners spent on their kitchens during the boom years. Prices start as low as $75,000 in Windsor, $119,000 in Niagara Falls and $125,000 in St. Catharines – the top three cheapest cities for first-time home buyers identified by a ReMax Ontario Atlantic Canada report yesterday.

"You're not getting the Ritz at these prices, and a lot will need some elbow grease, but they will be liveable first-time properties," real estate investor Mike Sergeant said.

An ailing auto industry in devastated Windsor means average prices have dipped 10 per cent this year alone. Buyers seeking entry-level homes can find houses for $75,000 in Windsor's East and Central neighbourhoods.

"While skittish purchasers remain cautious ... there are those who are venturing into the market," ReMax said.

And the price of entry is remarkably low: There were 24 sales under $60,000 in the downtown core. One property sold for $25,000.

"Affordability has greatly improved and buyers are firmly in the driver's seat in just about every market surveyed," said ReMax executive vice-president Michael Polzler.

Though affordability is improving, it's another thing to convince first-time home buyers to commit when they think housing prices are set to fall further. The Canadian Real Estate Board is forecasting an 8 per cent drop in home prices by the end of this year.

During the last quarter of 2008, first-time buyers "largely checked out," said Royal LePage CEO Phil Soper. "They're sitting at home, or renting. They don't have to buy."

However, as affordability improves, Soper expects first-time buyers to return in increasing numbers this year. In the Toronto market, almost 50 per cent of all February sales occurred under the $300,000 price point, compared to 43 per cent a year ago.

First-time buyers who are secure in their jobs are still favouring condos priced in the $200,000-plus range, despite warnings the sector may be overbuilt.

Detached homes in the city's east end start at $350,000 and are still out of reach for many. Starter detached homes in the city's central core start at $550,000.

While supply is up across the board, with a 19 per cent increase in listings, there is more demand in the lower end of the market.

With home prices and starts falling, builders are concerned about an Ontario Chamber of Commerce initiative that calls on the province to blend the provincial sales tax and Goods and Services Tax into a single tax. The chamber said streamlining could save $100 million.

That didn't sit well with developers, who shot back yesterday in a report by housing economist Frank Clayton for the Building, Industry and Land Development Association. Clayton concludes harmonization would result in a $46,676 increase in tax on an average new home in Toronto. "The adverse consequences ... would be excessive," he said.

RBC study finds homebuying intentions still strong

Opportunity awaits— two-in-three Canadians think it's a buyer's market
TORONTO, March 4, 2009 — According to the 16th Annual RBC Homeownership Survey, 65 per cent of Canadians think it's a buyers market right now and more than a quarter of Canadians (27 per cent) say they intend to purchase a home over the next two years, up four points from 23 per cent in 2008 - the largest single year increase since 2001. Additionally, almost half (48 per cent) indicate it makes sense to buy a home now versus waiting until next year.
The RBC survey found that younger Canadians are most likely to spark an upsurge in home sales. In the under 35 group, 48 per cent said they plan to buy, which is up sharply from 36 per cent last year. Renters also appear to be saying they are tired of paying someone else's mortgage payment, with 38 per cent planning to become homeowners in the next two years.
"The current economic environment does not appear to have dampened Canadians' overall confidence in the housing market," said Karen Leggett, head, Home Equity Financing, RBC Royal Bank. "Canadians continue to have an overwhelming belief in the long-term value of a home and we're seeing this in the buying intentions of many first time homebuyers this year."
A large majority of Canadians (83 per cent) remain positive that homeownership is a good investment. While the proportion is down slightly from 85 per cent in 2008 and from the all time high of 90 per cent in 2006, it is 10 points stronger than it was a decade ago (72 per cent).
Among those who intend to buy, three-in-ten say favourable housing price is a major reason driving their decision. In a marked change from last year, 54 per cent of Canadians believe housing prices will be lower in 2009, up from 31 per cent in 2008. Similarly, the study showed 14 per cent of Canadians believe their home has lost value in the last two years. Of these, most (54 per cent) think it will take three-to-five years for their home to recover its value.
"Low mortgage rates and favourable housing prices are influencing home purchase intentions this year and may be the reason why more Canadians are poised to purchase over the next two years," added Leggett.
The primary reason stated by homeowners not planning to purchase a home is that they are content with the home they have (60 per cent). Job loss/employment factors (eight per cent) as well as general concerns about the economy (six per cent) also influenced people's decisions not to buy a home.
RBC is the largest residential mortgage lender in Canada. As the country's number one source of financial advice on homeownership, RBC conducts consumer surveys as one way to provide insight to Canadians about the marketplace in which they live.
These are some of the findings of an RBC poll conducted by Ipsos Reid between January 6 to 9, 2009. The online survey is based on a randomly selected representative sample of 2,026 adult Canadians. With a representative sample of this size, the results are considered accurate to within ±2.2 percentage points, 19 times out of 20, of what they would have been had the entire adult Canadian population been polled. The margin of error will be larger within regions and for other sub-groupings of the survey population. These data were statistically weighted to ensure the sample's regional and age/sex composition reflects that of the actual Canadian population according to the 2006 Census data.

Central bank lowers interest rate again

There's no denying it now: Canada is in a deep recession.
The Bank of Canada cut the target interest rate to 0.50 of a percentage point, it's lowest level ever, and hinted that it might resort to measures other than interest rates to help boost the economy. The Bank of Canada also acknowledged for the first time that the economy is unlikely to recover by the end of the year. The central bank had previously made several optomistic forecasts for the fourth quarter.
The loonie fell to its lowest level in three months after the announcement to $1.2975 per US dollar.
The current rate of 0.5 per cent is about as low as the rate can go, and is essentially zero as far as economists are concerned. A zero per cent interest rate is impractical for several different technical reasons.
The key overnight interest rate, often refered to as prime, is the rate at which banks charge for overnight loans to eachother.
Mark Carney, the Bank of Canada Governor, said that it may be necessary to lower the key rate even further, although at this point other economic measures may be more effective.
"Given the low level of the target for the overnight rate, the bank is refining the approach it would take to provide additional monetary stimulus, if required, through credit and quantitative easing," Carney wrote in a statement.
Quantitative easing is the practice that the Bank of Canada uses to add to the money supply by selling securities to banks. If the government limits the number of securities available, the banks will find themselves with excess cash and expand lending.
"The outlook for the global economy has continued to deteriorate since the bank's January update, with weaker-than-expected activity in major economies," Carney said Tuesday.
"National accounts data for the fourth quarter of 2008 and other indicators of aggregate demand point to a sharper decline in Canadian economic activity and a larger output gap through the first half of 2009 than projected in January."
Canada's economy lost another 129,000 in January, a number much larger than what was expected and something Carney was unaware of when he made his statement.
Statistics Canada also said that Canada's economy shrank 3.4 per cent in the fourth quarter, the country's largest decline since the recession in 1991.
Canada's five largest chartered banks in turn slashed their key lending rates by the same amount of 50 basis points. This is the second time that the banks have quickly followed the Bank of Canada's move to reduce rates after being harshly criticized for gouging after not adjusting their rates to coincide with the central bank in 2008.
However, it seems the banks aren't really dedicated to helping the economy. Customers of CIBC with secure personal line of credits received the following notice along with their most recent statement.
"Effective April 6, 2009, the annual variable interest rate will increase by one per cent and will apply to all amounts owing on PLCs." The notice went on to say, "This change is a result of global credit market conditions that have increased costs associated with lending products."
Toronto Dominion Bank and the Bank of Montreal have quietly made similar adjustments to interest rates attached to personal lines of credit. To say this is contradictory to the Bank of Canada's efforts is a drastic understatement, however the banks have kept the adjustments very quiet and away from media attention.
Finance Minister Jim Flaherty has not commented on the banks' action. However he did have some advice for Canadians, telling them "to have confidence. This too will pass. We will come out of this and there will be opportunities as we do so."
Flaherty also said that the government will work with Bank of Canada to further stimulate the economy.
"They're [The Bank of Canada] running out of room on strict monetary policy of course and there are other things they can do," Flaherty told reporters when he was asked about the possibility of unconventional monetary moves.
"We have to make sure that the steps, in terms of the additional steps, are well co-ordinated between the Bank of Canada and the government of Canada."

Housing Affordability

Housing downturn — Canadian-style
Canadians have watched with amazement for nearly two years now at the collapse of the housing sector in the United States, the United Kingdom and other countries that experienced overvalued housing prices with the sense that markets in this country stand on much more solid ground. After all, the sub-prime business never represented more than a marginal phenomenon here; Canadian households, while carrying heavier debt loads than in the past, were not financially overstretched; Canadian banks emerged islands of stability amid the global financial storm; incomes remained well supported by steady job creation and a strong domestic economy; and the influence of speculation — especially on new construction — was deemed to be subdued.
Then, late in 2007, red-hot Alberta markets began to slide, followed earlier this year by British Columbia’s markets. Most recently, Saskatchewan, last year’s hotspot, and areas in Ontario joined the weakening trend. All of a sudden, Canada no longer appeared immune to a generalized housing downturn. In fact, the souring of economic conditions, eroding consumer confidence and, in some instances, past excesses are creating a downdraft that the majority of Canada’s housing markets will be hard-pressed to resist.
As a sluggish economy threatens income growth and makes households much more skittish about major financial commitments, issues of affordability are coming to the fore. Much of the market correction taking place in British Columbia, Alberta and, now, parts of Saskatchewan can be traced to very poor affordability levels in those provinces.
However, high home ownership costs are not unique to western Canada. RBC’s affordability measures lie above long-run averages in all provinces and across all housing segments, which suggests that the downdraft will be felt widely.
Still, the extent of “unaffordability” varies substantially by province, with measures running as high as 48% above average in the B.C. standard townhouse segment and as low as 6% above average in the Quebec detached bungalow segment. Overall, British Columbia, Saskatchewan and Alberta remain the least affordable markets in Canada (relative to their respective historical norms).
While the Canadian housing sector is undoubtedly entering a cyclical downturn, the risk of experiencing a U.S.-style meltdown is remote. The supportive factors mentioned above are still mostly in play and should provide enough backing to prevent markets from spiraling down even as the Canadian economy slips into recession.