It’s been a while since I spent any serious time talking about recent mortgage developments in Canada. As mortgage brokers we are most concerned about being able to give our clients the best possible advice in these rapidly changing times.This blog is designed to be a bit of a primer on major changes for home buyers, and some implications for our clients going forward.
The single biggest element that is changing is the end of the road of ultra cheap mortgages, whether for residential owners or for commercial property owners. While higher interest rates appear to be negative for the average residential consumer there is some potentially good news underlying the rising cost of money. Interest rates increase on positive economic news regarding productivity gains, employment gains and growth in the overall economy.
Ultimately, money is a commodity, especially when it comes down to the international trade in debt, represented by the Bond Markets, and increasing demand for debt both by governments and non-governments alike, represents a higher demand for it. Supply and demand are managed, to a degree by central banks around the world, with several explicit goals – first among those goals the prevention of run-away inflation as was experienced in the western world during the 1970’s and 1980’s.
During the recent recession starting a couple of years ago caused by the US housing meltdown, another major priority shifted the focus of central banks from inflation to the prevention of economic collapse and a potential worldwide depression. This resulted in central banks lowering the cost of debt by reducing the prime rate to historic low levels, .25% in Canada, for example, but also led governments to spend substantially more money than they have coming in from taxes from all sources, leading to ever increasing amounts of debt. However, all that debt has been slowly increasing the demand for debt capital by the same governments that have been overseeing the decline in interest rates designed to stimulate the economy.
Supply and demand have both been profoundly affected by government policies in Canada, and in our major trading partners. The world governments have been radically increasing their demands for debt capital and therefore putting increasing demand on the available capital. All of this demand is now showing up on the bond markets, forcing up the cost of debt to everyone, including consumers, business and governments.
Interest rates are going up. Most economists are expect them to rise around 2.25% in the next couple of years. What does that mean in regards to mortgage rates? This is a more complicated question than it appears, because mortgage interest rates are a consequence of a variety of forces in the marketplace rather than simply a function of supply and demand on the bond markets. The Bank of Canada prime rate is .25% right now, and most think it will rise in June or July by some amount. Nobody is guessing by how much it will rise, but my guess is that it will rise by about .5% in July and another .5% sometime this fall. But of course I could be completely wrong, or even way too low.
What I am correct about at this point is that the general trend in interest rates is up, both for fixed rates and for variable rates, both for consumers of residential mortgages and others. Assume that rates will rise to levels at or near the average rates for the past ten years or so, ever since the government first established inflation as the number one priority for the Bank of Canada.
Prudent advice would be to anticipate as much as a 3% interest rate increase over the next 18 months to two years. For most consumers this would suggest that locking-in fixed rates would be a sound policy, unless you have a lot of flexibility to deal with substantially increased monthly expenses for mortgage payments.
Also, don’t buy more than you can reasonably afford. Normally this would seem like elementary common sense, until you realize that 60% of new mortgages last year were variable rate ultra cheap mortgages, which could easily double or triple in cost for the next two years. Anybody who bought a house based on being able to keep his interest payments to around 2% is in deep trouble, and I hate to think about what these means to thousands of home buyers who bought very expensive homes at very cheap rates.
http://www.canadianmortgagetrends.com/canadian_mortgage_trends/2010/04/banks-see-275-rate-hike-in-19-months.html
For residential mortgages there are a number of new rules including a need to qualify for the Ban k of Canada Five Year Posted rate to any mortgage with a term shorter than five years, or for any variable rate mortgage. Applicants for five year term or longer mortgages will need to qualify on the basis of the contracted rate. This is a major change from current practices, and is in response to the high percentage of Canadians obtaining variable rate mortgages in these times of extremely low interest rates. The concern by the government is that people are taking out these ultra cheap mortgages without any ability to support them when the variable rate rises to historically more normal rates in the future. By forcing people to qualify at the higher rates it will reduce the exposure of the marketplace to a meltdown caused by a lot of people having to sell their homes because they can’t afford their mortgages as a result of rising interest rates.
Refinancing a home will also now be restricted to 90% Loan to Value instead of 95%, in an effort by the government to discourage Canadians from draining all of the equity out of their homes to pay off consumer debt. The general feeling is that if you have more equity in your home you will be less likely to default on your mortgage.
These two changes are both substantial, and in the author’s view, necessary, although not necessarily on the basis of any technical evidence supporting the policy change. Defaults in insured mortgages in Canada show no evidence of weakness or increasing defaults. However, it is prudent given the likeliness of rate increases to reduce the exposure of ordinary Canadians to default through bank loans.
Implications for revenue property borrowers and commercial borrowers will follow in my next blog.
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