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Market news, economic insights, mortgage strategies & tips. For all things mortgage, come enjoy our blog!
Market news, economic insights, mortgage strategies & tips. For all things mortgage, come enjoy our blog!
Amidst worries of inflation finally starting to creep in with our American neighbors, and concerns that, after 35 years of declining rates, this long term declining rate trend may finally be reversing, the question of whether to lock in that variable rate that has done so well for borrowers has become a valid concern. In this blog we’re going to give some perspective to these rate increases, outline reasons for & against future increases & discuss the questions you should ask if considering locking in your own mortgage.
We are currently just off the basement of a multi decade long term trend of declining interest rates, which began in 1981 when prime rate dropped from its high of 21.25%. Since then, the overall course has been down & we have hit historical lows for interest rates in what has been an unprecedented experiment in central bank policy. In fact, over the 5000 years of interest history, the world is at the lowest level ever recorded. From that perspective, one would assume we’re closer to the end of this long term cycle than the beginning, but the question is what is going to happen in the near term.
– lowering rates incent borrowing which leads to spending & investment, while raising rates are used to slow the economy & reel in inflation. While Canada had a far better year than expected in 2017, we are facing some major headwinds to overcome in the year ahead. For one, rising rates slows housing, which has been a big driver of the economy to this point. Higher rates can also strengthen the loonie, which negatively impacts exports & therefor manufacturing.
There is also the overall indebtedness of Canada to consider. Too many rate increases too quickly can effect repayment of loans & put Canadians under water on their debts. Additionally, NAFTA renegotiation & the lowering of the corporate tax rate in the States (making Canada less competitive) are two other pressing concerns for our economy. Overall, there is anything but an assured path to aggressive tightening of interest rates in the short term.
The yield curve plots short to long dated government bond yields (interest rates are priced off of these bond yields). A normal shaped yield curve is upward sloped & indicates investors expect longer maturity bond yields to be even higher in the future. Despite the short term yields rising roughly 1% over the last year in Canada, long dated bond yields have barely moved. The yield curve is still relatively flat, which suggests investors are not optimistic for long term growth & therefore skeptic to see higher interest rates.
The best research on fixed versus variable has come from York University professor Dr Moshe Milevsky. He found that borrowers were better off taking a variable rate over a longer term fixed rate nearly 90% of the time. Fixed rate borrowers pay for stability, while those with a higher risk tolerance, who can handle fluctuations to their payments, would benefit from that uncertainty by paying less interest. Years later he updated his study to determine if borrowers would be better off trying to time the market & lock in their variable mid-term. Even under the generous & unrealistic assumption that borrowers would be able to accurately forecast the future of interest rates, he found that individuals who attempted to lock in & time the market underperformed (83.3%) those who stuck with the variable (88.1%) & rode out their term.
You could be right in timing the bottom of this 36 year trend within 5% & still be off by 22 months. Given that fixed rates are priced off bond yields, and that the bond market has generally priced in increases by the Bank of Canada before they have happened (meaning fixed rates will go up before you’ll hear talk of prime rate increasing), don’t bother trying to time the market. Take a fixed term mortgage & sleep easy knowing exactly what your payments will be for the coming term, or take the variable & don’t worry about the impossible task of trying to time the market. Choose a path & stick with it.
Effective Jan 1 the newest mortgage rule was put into effect in Canada – the “stress test.” This video is going to give some background on mortgage stress tests, then explain the new rule.
Currently, if a borrower is buying with less than 20% down payment & is therefore getting an insured mortgage, they already have to qualify off of a stress test rate (being the 5 year posted rate, currently at 4.99%). For borrowers with 20%+ down, they can avoid this same stress test ONLY if they take a 5 year fixed mortgage (or longer), which means that if they want a variable or, say, a 2 year fixed, they would have to qualify off the 5 year posted rate not their actual interest rate.
The new requirement specifically impacts borrowers getting uninsured mortgages, which you can think of as borrowers with 20% down or more. Now, they will have to qualify for their financing based off a new stress test being their interest rate + 2%. So if they chose, say, a 5 year fixed mortgage with a rate of 3%, they would have to qualify based off a rate of 5%.
The irony of all this is that shorter terms generally mean lower rates, which therefore means that borrowers will qualify for larger mortgages taking shorter terms & shorter terms result in a borrower being more vulnerable to interest rate increases which doesn’t exactly benefit clients.
If you’ve bought a presale prior to these new rules being implemented & are curious how this will impact you, as long as you have a purchase contract dated prior to Jan 1, 2018, you’ll be grandfathered under the previous rules.
Additionally, you have a mortgage coming up for renewal & are not able to qualify to switch under the new rules, all is not lost. There are ways we can still qualify you off the previous rules.
If you’re looking to buy a place but can’t qualify for the price point you need under the new rules, give me a call. There are a still a few ways we can still get you into a purchase qualifying of your contract rate.
The new year has arrived & with it, a fresh round of mortgage rule tightening. The new restriction comes in the form of a “stress test” & applies to new mortgages with equity of 20% or more. Qualifying for these mortgages will now have to be done at a rate that is 2% higher than your contract rate.
Previously, a stress test was already in place for all insured mortgages (purchases with less than 20% down), as well as borrowers with uninsured mortgages that took a fixed term shorter than 5 years or a variable rate, meaning that if a borrower with 20% or more down chose a 5 year fixed, they could qualify for the mortgage based off their actual interest rate. Under the new rules, that will no longer be possible through major lenders.
Oddly enough, the new stress test can actually end up being more restrictive than that imposed on insured mortgages. A borrower with the bare minimum down payment of 5% has to qualify for their mortgage based off the 5 year posted rate (4.99%), whereas a borrower with a down payment of, say, 50% who takes a 5 year fixed rate of 3.2% would have to qualify based off the stress test rate of 5.2% (3.2% + 2%). The borrowers impacted by this change will qualify for maximum mortgage sizes of roughly 25% lower than under the previous rules.
My prediction is that the new stress test will actually end up making condos in Vancouver even more expensive, while also driving borrowers to shorter term mortgages & ironically making them more vulnerable to the interest rate fluctuations this was designed to protect them from.
People are always going to want to own property in Vancouver. If borrowers are qualifying for mortgages that are 25% lower, many are still going to want to buy, but will just have to look at lower priced property. Residents of Vancouver have seen the price of property accelerate at warp speed. The FOMO is real & many will be approaching this as a final opportunity to own in Vancouver, regardless of the size of place. This will funnel demand into the lower price points. Those who are no longer able to buy in the price point they want will continue to rent which will keep pressure on the rental market. Both of these would suggest condos are going to end up becoming even more expensive than they are currently.
As I’m sure many of you have heard, for the first time in 7 years the Bank of Canada has raised its key lending rate by 0.25%, which ultimately impacts variable rate mortgages & lines of credit, as prime rate will go up accordingly. This increase comes at a time when Canada is experiencing the lowest inflation level in nearly 20 years & in that sense, this move breaks from tradition. It is clear the Bank of Canada wants to raise rates pre-emptively to try claw their way out of this ultra low rate environment they have created & regain some ammo while they can before another slowdown hits the economy.
What does this mean to you? With the exception of one instance in the late 80s, the variable rate has always been a cheaper path than the 5 year fixed. While you do have the option to “lock in” to a fixed rate, you would be doing so into a higher rate & payment than you have currently.
Those riding the variable rate train have benefitted from some of the lowest interest rates in Canada’s history over the past 9 years. While, psychologically, a rate increase can drive many to panic, keep in mind that a 0.25% increase in rate translates to $12 / month for every $100k of mortgage (amortized over 25 years). In 2010 prime rate rose to 3%, remained there for 4½ years then dropped to 2.7%.
One of the greatest benefits of a variable rate mortgage is exit strategy as the penalty to break the term is just 3 months of interest. Under that light, a fixed rate mortgage can often be riskier path. If there is any uncertainty over the remainder of your term, this is something I urge you to weigh heavily.
There is no shortage of uncertainty in our world right now, both politically & economically. Central banks around the world find themselves in the extremely difficult position of needing to unwind their balance sheets & raise interest rates at a time when core measures are not exactly strong. The deflationary headwinds outweigh the tailwinds in my view so until there are greater reasons for optimism, my advice is to stay the course.
If you have any questions at all, please do not hesitate to get in touch.
A pre-approval may not be what you think. We in the industry should really change the name from “pre-approval” to “rate hold,” as that’s largely what this is.
A pre-approval is not a guarantee that you will get approval, nor should having one be reason to write a subject-free offer. In the best case, a pre-approval means a lender has reviewed your application, told you what mortgage amount you can qualify for & held a rate for you while you look for your home. What the lender doesn’t know at that time, though, is what property you are buying or if the information in your application is accurate, which are key aspects of getting a mortgage approved.
Because pre-approvals aren’t fully underwritten, they aren’t totally accurate. The last thing you want is to waste time looking at properties in a price range that you aren’t going to qualify for so make sure you are as detailed as possible in your application & have your broker review your documents early on to avoid surprises down the road.
What can go wrong? Well, what if the building you want to buy in is a leaky condo? Or a heritage house? Or has a commercial component? What if the property is on leasehold land? What if your offer price is higher than the property is actually worth? Maybe you wrote your expected income in the application, or factored in commission income without a 2 year history of that income. Perhaps your down payment is coming from a family gift but you wrote it as being part of your savings. The reasons for deals falling apart are endless. The reality is most borrowers are going to have a different idea about what is acceptable than the lender.
When you do find a property you’d like write an offer on, let your broker know as early as possible so they can begin gathering the necessary documents & reviewing options for approval. Getting as much done early on will avoid surprises & ensure a smooth approval.
One final note on pre-approvals is that over the last few years, many lenders have flat out stopped offering them or do them based on rates much higher than what you can get on a “live” deal. Setting aside funds at a specific rate costs lenders money, as does paying staff to review & issue your pre-approval. All this work is wasted if the lender doesn’t end up getting your mortgage. Lenders don’t start making money until a mortgage funds & I suspect more & more lenders will trim down their “pre-approvals” in the coming years.
The mortgage industry has completely changed in the last 2 months. With the last round of rule changes, we have now entered a new galaxy of complexity in our industry, where lenders all price their mortgages differently depending on the client, the property & the type of financing requested. It has never been more important for consumers to do their due diligence when shopping for a mortgage.
Before, if a borrower really wanted to do everything on their own & shop lenders themselves, they could. It would require a ton of work – completing many applications, setting up lots of meetings with mortgage specialists, and hours of online research – but for the motivated borrower, it was possible to become a well-informed consumer without drawing on a broker’s service (which is free, by the way). Now? Good luck!
Let me explain: the aftermath of the mortgage rule changes last fall has left every lender with not only drastically different policies than the next, but greatly varying criteria of what types of mortgages they offer & at what rate they will offer them. Even within a single lender’s range of options, the pricing now varies depending on the down payment size (less than 20%? 20%- 25% down? Or greater than 25% down? Greater than 35% down?), amortization & property price.
Many lenders now flat out will only do purchase & not refinances. Some will only do purchases for borrowers who pay for mortgage insurance. Many have eliminated niche programs such as rental purchases or have stopped funding mortgages on properties priced at $1m or higher. It has gotten to the point where brokers, the experts, will have a difficult time knowing what options are available to a client without reviewing their application & studying the matrix of lender policies & pricing nuances.
My point with all this is that it is more important now than ever before to use a mortgage broker. Not only that, but a broker with the experience & size of business to guide you in the best way possible, utilizing the widest range of lenders. Use the experts. If you love how your bank greets you when you walk in & have been with them for 30 years? Great, but understand that they are only 1 option out of 20+ national lenders, not to mention the local institutions. With every bank & nonbank lender sporting drastically different options than the next, there is a very small chance you are getting the best product only speaking with your bank.
The best value you can ask for is someone well versed in the field to help you navigate the wide range of options. Call a broker. Use the expert.
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City Wide Mortgage Services – Zupan Mortgage Services (E, & O, E.).