Mortgage Rates & Mortgage Broker News in Canada

Mortgage-Freedom Is Key For Retirees

75% of households own a home by retirement, and almost 3/4 of those don’t have a mortgage. That’s according to a Statistics Canada study issued on Monday.

StatCan says, “The economic benefit of owning a home is equivalent to the rent that does not have to be paid.”  And that benefit is significant because, as StatCan notes, net incomes decline by about 45% between a household’s peak earning years and the 70-plus retirement-age class.

Not surprisingly, that makes mortgage-free home ownership a vital contributor to most senior citizens’ effective household incomes.

Marketing Low Rates

Canadian Mortgage Professional (CMP) ran a story last week that caused quite a stir.

The article was about a new low-rate promotion from CanEquity. Brokers commenting on the story criticized CanEquity for claiming to have the “Lowest Mortgage Rate in Canada,” not advertising the actual rate, and not fully explaining the fees that applied to the offer.

CMP was also taken to task for running the story, which some commenters felt was inappropriate due to the nature of CanEquity’s promotion. (Here’s CMP’s response.)

All this hubbub ended up raising a number of points. Among them:

1. Advertising the “lowest rate in Canada” isn’t the world’s best idea. In particular, it can put you on the wrong side of regulators (and the industry)—unless you can actually prove there are no lower rates in the entire country.
2. If you’re going to charge an administration fee, it’s a good idea to explicitly describe how it’s calculated (Following CMP’s story, CanEquity withdrew the admin fee that applied to its rate promotion)
3. There’s a contingent of brokers who decry competitors that center their marketing around rock-bottom rates. They feel it cheapens the mortgage planning profession.
4. Many brokers are critical of lenders for offering ultra-low rates and cutting broker commissions in the process.

Points 1 and 2 are self-explanatory. Points 3 and 4 are where the debate heats up, presenting us with two central questions: is there anything wrong with advertising ultra-low rates, and what should we make of lenders who pay brokers less in return for lower rates?

Is there anything wrong with advertising ultra-low rates?

Most would say no, as long as it’s done honestly.

The downside is that the value of a mortgage planner (his or her advice and service) is often obscured in our quest for the lowest rate. Instead of choosing the most skilled advisor, consumers are being conditioned by the Internet to first call the broker with the lowest advertised rates.

As a result, it’s easy to see why Internet brokers are so eager to compete on rates.  Rate comparison sites are putting a lot of pressure on brokers nowadays. Anthony Almeida, CEO of CanEquity (one of the biggest Internet mortgage brokers in the country) says, “We're an online business and you can draw a parallel to other competitive businesses online. Our job is to always try to evolve…Five years ago, it might have been advice that people sought when visiting our website. Today, it's a more rate-sensitive business and we need to stay ahead of the curve."

The side effect, as time goes on, is that most brokers will find it harder to compete unless they are web-savvy and aggressive on rates.

Note the word “most” in that last sentence. Some of the most successful brokers in the country never advertise rates. These brokers will continue to thrive because of their service, skill, and referral networks. But even the truest professionals will lose some business at the margin as the next generation gravitates to low-rate providers.

What should we make of lenders who pay brokers less in return for lower rates?

If you’re a homeowner, you’re probably saying, “Who cares. Give me the lowest rate!” If you’re a mortgage planner, you’re a bit worried right now, even if you’d rather not admit it.

In our view, we’re at a major turning point in the industry.  Over the next few years some brokers could take a 25-45% pay cut because of the legion of brokers willing to give up 1/2 their commission to advertise lower rates. Are deep discount lenders propagating this trend? Absolutely, but free-market pricing can’t be restrained.

Consumers may indeed get the lower rates they crave in the end, but it won’t be without a cost. The quality of advice and personal service could deteriorate over time as brokers’ reward for devoting time to a deal and honing their craft may no longer be as enticing.

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Sidebar:  A good mortgage planner adds value beyond the interest rate by:

• Helping identify the lowest-cost term (which can impact total interest cost far more than a 10-20 bps rate discount)
• Comparing numerous lenders to find the best combination of features and rate
• Properly structuring difficult applications for the greatest chance of approval
• Structuring debt to help homeowners accumulate assets.

Good advice always comes at a price. The exception is when technology advancements deliver that advice more efficiently. That hasn’t fully happened yet in the mortgage planning business, but the future may bring what we haven’t yet envisioned.

2010’s First Dip In Home Prices

The average Canadian home value fell 1.2% in June. It was the first drop of 2010.

There’s one thing about price declines:  They’re good at making people ask: “Now what?” 

The answer is pure speculation, as usual, because housing—like the economy, interest rates, and the weather—can’t be predicted long term.

Nonetheless, while one month does not a trend make, there is a somewhat bearish tone in real estate these days.  Below are the latest assessments from some well-known observers...

• “With interest rates on the rise, housing affordability and home sales activity are expected to continue to erode over the second half of 2010.” – Gregory Klump, chief economist, Canadian Real Estate Association
• "An expected increase in the supply of homes on the market will now bring stabilization in prices, and in some cities we will see both prices and unit sales decline towards the end of the year.” -- Phil Soper, president and chief executive, Royal LePage Real Estate Services
• “As we cross into the second half of the year, we expect to see a continued easing in activity.” – TD senior economist, Pascal Gauthier
• “…excesses in one direction are generally followed by excesses in the other direction…In a nutshell, there's more air to come out of this Canadian housing balloon.” -- Gluskin Sheff + Associates Inc., economist, David Rosenberg

Few analysts predict an outright crash, though. Most are calling on a strengthening economy and employment to pad the fall. But again, it’s all speculation based on future uncertainty.

That uncertainty is prompting some first-time homebuyers to think extra long about their buying decision. In the last few months, we’ve come across a fair number of home buyers who are hesitant to buy because they expect prices to fall.

CIBC, for example, expects a 5-10% drop by summer 2011. Suppose, for illustrative purposes, we averaged that to a drop of 7.5%.  If the economy continues its recovery and fixed rates rise 1%, the mortgage picture could pan out something like this (these aren’t predictions, just a hypothetical):

TODAY

• Average Canadian home price: $342,662
• Typical 5-year fixed rate:  4.09%
• Payment w/ 35-yr amz & 5% down:  $1452

JULY 2011 (HYPOTHETICAL)

• Average Canadian home price: $316,962
• Typical 5-year fixed rate:  5.09%
• Payment w/ 35-yr amz & 5% down:  $1526

Thus, a person looking to buy an average house in this scenario pays $74 more a month by waiting a year to buy, but saves $25,700 on the price.

Mind you, you have to adjust for rent expense (people need to live somewhere while they’re waiting to buy), property taxes, etc. But still, someone could easily make an argument that waiting to buy is the most economical decision in certain real estate markets—even if rates go up.

This isn’t meant to scare people from buying homes. But if you’re looking to buy with only 5% down, it should make you think a bit. People with little equity need to have a long-term time horizon and solid employment prospects, because real estate risk has undeniably increased.

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Sidebar Question: What’s the probability of home prices dropping the month after the first decline in six months?

Answer:  45% (based on 55 occurrences since 1980)

The Predictive Power of the Yield Curve

Here’s an interesting report from the Globe & Mail on the probability of recession, as predicted by the yield curve. See this story.

The yield curve is a line chart that connects interest rates for range of securities that all have equal risk, but different maturity dates. Below is a chart of Canada’s government bond yield curve.

The Globe writes that inverted yield curves (short rates above long rates) “have preceded each of the last seven recessions.”

The Cleveland Federal Reserve says: “The rule of thumb is that an inverted yield curve indicates a recession in about a year.”

Below is a snapshot of today’s curve. You’ll notice that it is upward sloping and definitely not inverted. For those who put weight in this indicator, its current shape portends economic growth to come—which in turn suggests some degree of higher rates down the road.

Of course, it pays to remember that no indicator is foolproof (the yield curve has generated false signals in the past). Moreover, as we saw in April and May, bond market sentiment can change on a dime.

Paid Co-Signor Found Liable to RBC

An Ontario court has found an unwitting mortgage co-signor liable to RBC for over $108,000.

The loser in the case was a regular working mom with three kids. Her mistake was accepting payment of $6,000 from strangers to co-sign a mortgage that later turned out to be fraudulent.

Moreover, the court ruling showed that she barely read the mortgage documents she was asked to sign, and allowed fraudulent income documents to be used in her name.

Madam Justice Anne Molloy of the Ontario Superior Court of Justice summed up her decision by saying:

• “She (the defendant) was foolish to sign documents she did not read and did not understand,”
• “She was foolish to rely on strangers to the extent she did.”
• “She had the opportunity to tell the Bank the true nature of her involvement, but did not do so.”
• “That is her own responsibility, not the fault of the bank.”

Apparently there are still plenty of oblivious accomplices willing to take money for use of their own good name and credit. Court rulings like this are a reminder that free lunches still don’t exist—especially when it comes to helping someone you don’t know get a mortgage.

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Here is the full case decision.

Here is analysis by the Toronto Star’s James Daw.

“Wilfully Blind”

That’s what BC’s Civil Forfeiture Office calls Royal Bank (RBC) and Bank of Montreal (BMO), according to the Vancouver Province.

The charge results from RBC and BMO allegedly taking a blind eye to mortgage approval standards in the following case.

The two banks reportedly lent a total of $1 million+ to a suspected Vancouver criminal. The security for their mortgages was a grow-op.

BMO reportedly approved the man for $976,000 on the property—which was bought for $980,000. RBC then supposedly lent him $70,000 two days after the house was raided by police.

In both cases, the man couldn’t prove his income and had zero or little equity. The house had also been established as a known grow-op before the mortgages.

This is obviously a PR “disappointment” for the big banks (see Canada’s Biggest Mortgage Fraud for the prior one).  If true, it reinforces the point that non-bank channels are not the only occasional facilitators of mortgage fraud. Despite all their supposed checks and balances and trained underwriters, banks also make “mistakes.” Fortunately, these kinds of egregious oversights are far from commonplace.

For the record, both banks appear to have denied these allegations according to the Vancouver Province. We’ll follow up on the outcome when more is known.

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Sidebar:  BC’s Civil Forfeiture Office launched in 2006, and works with law enforcement agencies to seek the forfeiture of assets obtained through criminal activity.

Customer Data Protection

Extrapolating is an innate human tendency. So when people read in the papers that a small group of mortgage brokers failed to protect client data, it damages the reputation of the entire broker channel.

The Privacy Commission’s report last Tuesday will likely prompt that sort of extrapolation.

Read on…

Variable-Rate Rulebooks Differ

RBC has an advantage that other big banks don’t.

Last we heard, RBC is the only Big 6 bank that still uses a 3-year fixed rate to qualify conventional, variable-rate borrowers.

The other five big banks use the higher Bank of Canada 5-year fixed qualifying rate. (This means they calculate your payment based on a 5-year posted rate for debt ratio analysis purposes.)

That’s unfortunate for those five banks because this rule disadvantage is costing them good-quality business. We’ve talked about it with several big brokers. By and large, they’ve moved some variable-rate business away from lenders who qualify conventional mortgages with a 5-year posted rate.

RBC loves it because variable-rate mortgage shoppers with slightly higher debt ratios have no other big bank choices. (Keep in mind, RBC’s risk is mitigated because its applicants are still well-qualified, have 20%+ equity, and 40-42% maximum total debt service ratios).

What does the above difference in rules actually mean in practice?  Well, suppose you make $60,000 a year and have 20% down...

A 3-year fixed qualifying rate of 3.85% means you’ll be approved for a $291,000 variable-rate mortgage.*

A 5-year posted qualifying rate (5.99% currently) means you’ll be approved for only $231,000. That’s 21% less mortgage just because you chose a different bank.

RBC isn’t the only one benefiting from more liberal variable-rate qualification policies. Smaller lenders with similar guidelines are also enjoying a volume boost. Examples include ING Direct, Merix Financial, Street Capital and others. In fact, some would say the new qualification rules are one of the better things to happen to non-bank lenders in quite some time.

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* Assumes no non-mortgage debts, a 35-year amortization, and a conservative lender-imposed 32% gross debt service ratio.

LTVs Of CMHC-Insured Mortgages

It’s a common perception that mortgage default insurance applies to only high-ratio mortgages. That’s not actually the case.

CMHC had $472.6 billion in mortgage insurance outstanding as of December 31.  Of that total, 71.1% of its insured mortgages had a loan-to-value of 80% or less, based on current home values.

Only 4.5% had LTVs over 95%, and roughly 87% of CMHC-insured mortgagors had 10% or more equity.

(Source:  Insurance-in-force data from CMHC’s 2009 Annual Report)

Nix the Bonuses

Suppose you’re a car salesperson and your boss offers you a $1,000 bonus if you can sell a Toyota Yaris for $50,000.

Would that get you excited?

Us neither. Who wants to stick a poor customer with an overpriced product to make a few extra bucks? (If you answered, “I would,” don’t bother reading further.)

Yet, it’s sometimes accepted practice for lenders to offer bonus compensation to sell mortgages at above-market rates. No offense to any of our lender partners, but this type of compensation scheme doesn't exactly scream of fiduciary responsibility.

It’s even worse when rates should be dropping. Look at our current market scenario for example.

On March 1:

• The 5-year bond yield was 2.52%
• A deeply-discounted 5-year fixed rate was ~3.69%.

As of yesterday:

• The 5-year bond yield was 2.52%
• A deeply-discounted 5-year fixed rate was ~4.29%

That’s a 60 basis point higher rate today, despite yields dropping almost 70 basis points in the last month. There’s no question that 5-year fixed rates should be lower than they are. Yet, most lenders are keeping them inflated.

Instead of lowering their rates, some lenders are offering brokers incentives to sell higher rates. This practice isn’t doing brokers any favours, and it sure as heck isn’t helping customers.

Most, in our business, would rather see lenders avoid incentives not aligned with the customer’s best interests. Lenders could then pass along lower rates and help brokers be as competitive as possible in the marketplace.

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Counterpoint:  This isn’t meant to indict the lenders who offer these incentives. All are, in fact, very reputable organizations. The problem is, there are still competitive pressures (vestiges of yesteryear), that drive these rate-based incentives.

Moreover, in our current market, lenders have run these promotions expecting rates to rise, or remain stable. With yields plunging unexpectedly, certain lenders are now stuck honouring these bonuses, and maintaining higher rates to compensate.

Shut Out From Variable-Rate Mortgages

Only 5% of new high-ratio mortgages have had variable rates, versus 15% six months ago.*

People are avoiding variables not just for fear of rising rates, but because many no longer qualify.

This was not to be unexpected (see: The 5-Year Funnel). Up until April 18, a variable-rate mortgage required you to prove you could afford payments based on a 3-year discounted rate (e.g., 3.75%). 

Now, the government requires variable-rate applicants to prove they can afford payments at the Big 5 banks' posted qualifying rate (6.10% today). That makes it distinctly harder to keep your debt ratios within lender limits.

The kicker is that you can’t change lenders at renewal without requalifying. Therefore, if you don’t have 20% equity at maturity you could be stuck in another 5-year fixed mortgage (possibly at your existing lender’s “rack rate”). If you instead want to switch to a variable or 1-4 year fixed term, your debt ratios will have to fit under the much stricter government guidelines at that time.

Of course, those guidelines will get tougher if fixed rates rise.

Today’s 6.10% qualifying rate is 435 basis points above what most borrowers are getting on new variable-rate mortgages. However, in years prior, most lenders considered 150-200 bps a reasonable number.

This is all pertinent because, as experts agree, variable and short-term mortgages are often the best way to keep lender’s hands out of Canadians’ pockets. With many financially stable Canadians now being unable to choose variable/short terms, lenders will get richer and many borrowers will get poorer.

It’s therefore somewhat intriguing that the federal government chose the posted 5-year fixed rate for its new qualifying rate. We heard they were also considering a spread above prime (like prime + 3%).

It makes one curious about the logic that went into the final decision. Is there a real threat of sustained 4.35%+ higher rates?  Or did the powers that be set the bar overly high to herd people into 5-year fixed mortgages—which just happen to be more profitable?

Maybe the latter is just too cynical a thought…

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(* Source: Genworth Financial Canada’s Peter Vukanovich, as quoted in the The Gazette; Reporter: Garry Marr)

Hybrid Mortgages Catching On

Investors like to avoid putting all their eggs in one basket. But this philosophy has been slow to catch on in the mortgage market.

94% of people still choose either fixed or variable rates, says CAAMP. Very few choose a combination of both.

That may be changing, if yesterday’s RBC/Ipsos Reid poll is right.

According to RBC, 40% of prospective homebuyers (people who plan to buy in the next two years) intend to take out a hybrid mortgage. That compares to 32% in last year’s survey.

These stats are a little hard to grasp given CAAMP’s recent mortgage survey. It suggests only 6% of Canadians have actually chosen a hybrid mortgage in the last year. However, Ipsos Reid’s Sean Simpson, says: “I would account for the difference by saying that one is an outlook while the other is retrospective.”

Simpson notes that, “Looking forward to the next two years, there is much more uncertainty in the direction of interest rates.” He says that Hybrids are, therefore, becoming more attractive since they let people capitalize on low rates while retaining an element of security.

Based on what an RBC spokesperson told us, hybrids may be catching on fast. In terms of the number of new buyers choosing hybrids, RBC says: "We have been trending similar to the survey results over the last quarter."

Marcia Moffat, head of Home Equity Financing at RBC, adds: "As consumers begin to learn about the benefits of mortgage diversification, we're seeing more homebuyers gain a better comfort level with adding floating rate mortgage options."

From our own anecdotal observations, that appears to be the case. We’re not seeing anywhere close to 32-40% of borrowers choose hybrids, but there’s been a noticeable increase in hybrid mortgage inquiries compared to last year.

The academic research supports hybrids as well. Dr. Moshe Milevsky--Canada’s most quoted mortgage researcher—says: “Nobody can truly predict how rates will move over a five-year period. It’s just that simple.”

He, therefore, believes hybrids are a good form of mortgage risk management. “People should strongly consider mortgages that are part fixed and part floating,” he told us last year. Interest rate diversification benefits borrowers just like it benefits investors who buy portfolios of stocks.

Of course, if history is a guide, well-qualified borrowers may save more money by simply choosing an ultra-low variable rate, or a 1-year fixed. But not all borrowers are in the same boat. Homeowners with only moderately strong personal “balance sheets,” can’t afford to dismiss the concept of risk management. 

Many moderately-strong borrowers will, in fact, assume the risk of putting 100% of their mortgage in a variable rate. These folks will probably never realize the value of rate diversification/risk management unless the “worst case” materializes…and then it’s usually too late.

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Sidebar:  Here’s a partial list of lenders who currently offer hybrid mortgages:

• ATB Financial
• Canadiana Financial
• HSBC
• Laurentian Bank
• Merix Financial
• National Bank
• RBC
• Scotiabank
• Various credit unions

If we forgot any major ones, let us know and we’ll add them to the list.

This list does not include all lenders that offer readvanceable mortgages.  Readvanceable mortgages often include a fixed portion and line of credit (LOC) portion. That technically makes them a form of hybrid mortgage as well, assuming that part of the mortgage is put in the LOC.

The Rise of Credit Unions

A quick glance at today’s Globe & Mail mortgage rate tables shows credit unions with nine of the ten best five-year fixed rates.*

(Click image to enlarge)

In the Financial Post’s mortgage tables, credit unions make up 10 of the 15 lowest rates.

On any given day, there are numerous credit unions (CUs) across the country with excess cash to lend. More and more, they’re using cutthroat rate promotions to lend out that cash and attack their big bank competitors.

In the last month, for example, we’ve seen surprisingly aggressive promotions from Vancity in Vancouver, First Calgary in Calgary, and Meridian in Toronto. In each case, their promo rates have been well below the lowest advertised rates of any competitor.

From a mortgage customer’s standpoint, CUs offer some key advantages:

• Low rates (when promotions are available)
• Profit sharing (see Vancity & DUCA’s dividend policies, for example)
• More flexible underwriting in their local markets (Vancity’s director of mobile sales and brokerage, John DeRose, says: “We understand the [local] market…we don’t have to go back east to get an answer.”)

Of course, credit unions sometimes have their cons as well:

• More loan conditions, which may include extra documentation requirements, membership agreements, opening of chequing accounts, personal references, etc.
• More restrictive portability (there’s typically no porting if a borrower moves across provincial borders)

From a broker’s standpoint, CUs have generally been a “use em when we need em” type of lender.  They’re generally not the average broker’s first choice of lender. Rightly or wrongly, that is probably due to the perception that CUs:

• Have widely differing and sometimes poorly documented lending guidelines
• Are slower with approvals and fulfillment of conditions
• Often don’t pay the same level of compensation (they often have hard-to-attain volume bonus levels or no volume bonus at all).

(Again, there are numerous exceptions and these are not blanket statements about all CUs.)

From our viewpoint, CUs are like any other lender. When they have the best overall deal for our clients, we send them the business. Personally speaking, we’ve had great experiences with a number of credit unions. They’re typically very relationship oriented and they often have a greater propensity for common sense lending.

It’s also nice to see credit unions making a push for more broker business. We keep an in-house database of lenders and in the past three months, we’ve added five CUs with brokers channels, and removed just two that have closed their broker channels.

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Looking ahead…

Canadian CUs have over five million members and 19% market share in residential mortgages. Those numbers may grow noticeably once federal legislation allows them to lend across provincial lines.

"We think this is historic legislation," says Tracy Redies, CEO of Coast Capital Savings, one of Canada’s largest CUs.

CUs are also being aided by the support of credit union centrals. Moody’s analyst, Ali Mozaffari, says, “These [centrals] provide member credit unions with vital supports, such as access to technology, funding, liquidity, and payment-clearing.”  He says that credit union centrals are providing the framework for future CU growth.

Speaking of growth, CUs are currently growing faster than the big banks--according to Moody’s--and there’s no sign of that growth reversing.  Homeowners and brokers should, therefore, expect to hear more from credit unions in coming quarters.  Their battle for mortgage market share will be increasingly noticeable as time goes on.

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* Note: The rate tables you’ll find in the media do not contain all rates in the market. They leave out many promotional rates and broker rates. Nonetheless, credit unions are well represented when it comes to the country’s best rates.

(Partial sources: A Union I Want To Join by Garry Marr, Financial Post; Small Players, Big Moment by Nicolas Van Praet, Financial Post)

Big Banks Set Higher Qualification Rates

Lenders have started announcing their new debt servicing policies this week. One big one taking effect on April 19 is the posted qualification rate.

So far, the big banks (like TD and Scotia) seem to be applying this new posted qualification rate to both high-ratio and conventional mortgages, (despite CMHC only requiring it on insured mortgages over 80% loan-to-value).

Meanwhile, some smaller lenders have said they will not be qualifying conventional mortgages with the 5-year posted rate.  Instead, they’ll measure borrowers against a lower rate--like a 3-year fixed (which is the current standard).

That gives these smaller lenders a new potential edge versus the banks. The reason being: 80% of mortgagors have at least 20% equity.  Those with higher-than-average debt ratios might no longer fit at a bank that uses the 5-year posted rate to qualify variable and 1- to 4-year mortgages.

Then again, a bank may not necessarily want those borrowers. A bank may prefer to keep its guidelines consistent across the board. It’s easier that way for efficiency, risk considerations, and potentially for securitization purposes.

Countdown To The New Rental Rules

In seven days the world of small-rental financing will change drastically.

As we wrote in February, the nation’s biggest mortgage default insurer (CMHC), is modifying its rental property qualification criteria.

The changes will affect anyone who needs a CMHC-insured mortgage to buy or refinance a 1-4 unit rental property.

More on:  The New Rental Rules

Banks Strive To Be More Advice Driven

This came from yesterday’s Financial Post:

(BMO) doesn't want to just market mortgages to customers. It wants to advise them.

"Advice and guidance is core to our brand promise."

The quote is from BMO executive, Frank Techar.

Don’t be surprised if you see more “advice-oriented” marketing from the big banks in coming quarters.  BMO, RBC, Manulife and other non-broker lenders will use the “advice” angle as a key selling point.

Advice is a major differentiator for mortgage planners, who generally:

• Are independent
• Specialize solely in mortgages
• Employ analytical tools and research when making mortgage recommendations
• Compare mortgages from dozens of lenders, as opposed to selling their employer’s (i.e., bank’s) one line of products.

Banks realize that this is an advantage of mortgage planners and they would love to align themselves in this respect.

As a result, banks will likely be stepping up their investments in advice-centric marketing, resource-based mortgage websites, mortgage advisory technology, and additional sales force training.

The reality, however, is that while banks’ internal sales forces may be competent, the bank business model makes it near impossible for them to be objective.

Dropping by a bank for a mortgage is not unlike walking into a Buick dealership. The salespeople may have quality cars to sell, but they’ll never tell you that a more suitable car exists at the [insert your favourite car company] dealership down the road.

By contrast, mortgage planners know the pros and cons of numerous mortgage products—even products from competitors. Admittedly, most planners don’t deal with every lender, but they nonetheless provide many more mortgage options to clients than a bank branch can. And, unless banks radically change their business models, that will always be an advantage exclusive to the broker channel.

In the next few years, it will be essential for brokers to capitalize on this advantage to boost broker market share. We, as planners, owe it to each other to represent our industry well. The best ways we can do that is by enhancing our trusted advisor role and operating with the highest standards of professionalism. That means, for example:

• Thoroughly analyzing a client’s present and future cash flow, financial goals, and risk factors before making a recommendation. (Brokers who think they can survive as “order takers” [without adding tangible value] should probably find other work.)
• Keeping up-to-the-minute on rates, mortgage research, products, and lender guidelines
• Performing detailed amortization comparisons to show clients which term is best for them
• Not making generalized statements like “This is the best mortgage there is” or “this is the best rate in the market” without actually having compared all lenders.
• “Letting a deal go,” on occasion, when you know a client can be better served by a lender you don’t deal with.

Our industry, through the efforts of our trade groups, regulators, and brokerage executives, has strived hard to instil the importance of quality advice. As mortgage planners, we must continue to elevate our trusted advisor status so we’re ready for when the banks start positioning themselves in a similar fashion.

Fixed-Prime Spread At A 30-Year High

The spread (difference) between discounted 5-year fixed and 5-year variable mortgage rates is currently about 240 basis points (bps).

Based on our estimates, (we don’t have historical pricing on discounted fixed and variable rates), that is one of the biggest spreads in a very long time.

If you compare the posted 5-year fixed rate to prime rate, the spread between the two is 360 bps.

That’s the biggest spread in the last 30 years (based on monthly data from the Bank of Canada). Click on the chart below for a close up.

Technically, today’s posted fixed-prime spread is tied with the 360 bps reading we saw last summer.  The difference is that variable rate discounts last summer were nowhere near the prime - .50% we have today.

To put it another way, today's plump fixed-prime spread indicates what many already know:  fixed rates are selling for a major premium over riskier variable rates.

This is not meant to be predictive, but consider this:  If you look back to 1980 for cases where there’s been a 2%+ fixed-prime spread, prime rate has never averaged more than 1.75% higher in the five years that followed.

Will 2010-2015 be the first such instance?  Time will tell.  But one thing’s for certain.  Today’s fixed rates are trading with a huge built-in “insurance premium,” and the 2.40 percentage point edge gives variables a big head start as we move into the next rate hike cycle.

Cutting Corners With Income Property Financing

“There’s going to be a dramatic increase in mortgage fraud,” Don Campbell told the Financial Post last week.

Campbell runs the Real Estate Investing Network and says the fraud will stem from CMHC’s new rental financing rules.

The new rules, which take effect April 19, require borrowers to put down 20% when applying for insured financing on rental properties (up from 5% today).

CMHC is also changing its debt service calculations to make it harder to rely on rent as a source of income for qualification purposes.

Campbell thinks people will therefore try to skirt the rules in increasing numbers. They will do so, for example, by stating that they intend to live in a property as their principle residence, when they really plan to rent it out.

People also try to call rental properties “second homes.” We know because we’ve lost a few deals to branch reps and brokers who facilitate these kinds of deals.

Mortgage broker, Peter Kinch, tells the Post: “I'm shocked by the number of bankers who will say, ‘Let's call this owner-occupied so it'll be easier and we won't have to go through the hassle.'”

Regardless of whether you’re a broker or bank rep, misstating occupancy is a dangerous game. If you’re caught knowingly processing a fraudulent application for a customer, your reputation could be toast, your license suspended or revoked, your employment terminated, and your lender access cut off.

It’s not even close to worth it, but people don’t think they’ll be caught, so they do it.

Of course, lenders and CMHC are well aware that people try to cheat the system by not disclosing the true occupants of a property. After April 19, they will likely scrutinize multi-property applicants with even greater intensity. In some cases they may require proof that a property will be owner occupied.

As always, the best path is the right path. Fraud is fraud and the monetary “reward” for bending the rules is never worth the stress.

Anticipating Rate Hikes

Anticipation isn’t just a Carly Simon song.  It’s a key characteristic of bond traders.

That characteristic drives interest rates day in and day out.

People often wonder how fixed mortgage rates could increase when the economy is so tentative and the Bank of Canada (BoC) is on hold. Bond traders possess the answer. 

Fixed rates are guided by the bond market (which sets the rates lenders pay for fixed-rate mortgage money). It’s a market that is incredibly anticipatory. In other words, bond traders take positions well in advance of significant economic trends.  Usually, by the time the central bank says, “OK", It’s time to raise rates,” the bond market has already factored in the hikes.

This chart below displays the last four U.S. FOMC rate cycles.  It shows how bonds often sell off months before monetary policy rate increases--which are indicated by the red arrows. (The same principle applies to Bank of Canada rate increases but we didn’t have a BoC chart handy.)

As bond prices drop, rates move higher (bond rates and fixed mortgage rates).

The odds are decent that the same pattern will repeat itself this time around.  If so, fixed mortgage rates will likely rise ahead of the first Bank of Canada rate increase.

Chart: Courtesy of Action Economics

Yields and Fixed Mortgage Rates

Mortgage rates and the bond market have a nice little marriage; 9+ times out of 10, when bond rates rocket higher, fixed mortgage rates move up too.

As seen in the chart below, 5-year fixed rates and bond yields track each other fairly closely over time. In fact, on a monthly basis going back to 1980, there’s been a 97% correlation between the two.

It’s not a perfect marriage though, as we’ve seen recently.

On March 9, mortgage rates and the bond market unexpectedly kicked their relationship to the curb. Yields went way up, and mortgage rates actually fell slightly.

Banks are behind this pleasant divergence. In a rush for market share, they’ve started ‘buying’ customers with, what some say, are “unsustainably low” mortgage rates. (See “Banks Wage War”)

Put another way, big banks are pricing 5-year fixed mortgages at unusually low spreads above bond yields.

This is a party for homeowners. You don’t find 5-year terms at 70-85 basis points above the GOC very often.

Hopefully this “unsustainable” trend can be sustained well into the future. But odds are, spreads will normalize after the spring (at least until the banks decide to ‘give away’ mortgages once again).

This is far from the first time that fixed rates have drifted apart from bond yields. From late 2007 to mid 2009, spreads were way out of whack. The credit crisis kept mortgage rates high while bond yields dropped to multi-decade lows.

Everything needs to be put into perspective though. Despite deviations from the norm, the norm isn’t dead yet.  In general, lenders still need to pay bond rates for mortgage money, and they still have similar costs as before.

So when yields go one way, and fixed mortgage rates go the other, remember they’re still married. They’re just temporarily separated.

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Sidebar:  Speculating on long term rate direction is like flipping a coin. It’s almost certain you’ll be wrong as much as you’re right.

Yet, when you see a big move in yields, on a short-term basis, there’s usually predictive power there. 

This comes into play when you want to lock in a rate on a new mortgage.  If you see yields jump 1/4 point, for example, it’s usually worthwhile to move quickly and get a rate hold.  If you don’t, there’s a good chance you’ll pay a slightly higher rate. 

Paying a fraction of a percent more isn’t the world, but the extra interest does add up over five years.

Whenever we see yields move in big spurts, we write about it here. When you see these stories, it helps to remember:

• The short term isn’t the long term. If you read that rates may go up next week,” that’s a short term statement. Economic news could come out two weeks later and drive rates the other way.
• The relationship between bonds and mortgage rates isn’t perfect, and even short-term forecasts won’t always be accurate.

That said, over the long run you’ll be right far more than you’re wrong by assuming fixed rates will track bond yields.