Mortgage Rates & Mortgage Broker News in Canada

Pre-Paying a Mortgage Before Discharge

Homeowners who break a closed mortgage before maturity will often make a pre-payment before the mortgage is discharged. 

The idea is to reduce the mortgage balance and thereby pay less of a pre-payment penalty.

It’s a great idea if you have the funds to do it. Remember, however, that lenders have different policies on how close to the payout date you can make a pre-payment.

Some lenders, for example, won’t allow pre-payments to be made within 30 days of the date of discharge (the date you pay off your mortgage in full).

Therefore, if you plan to pre-pay a portion of your mortgage to reduce your penalty, remember to do two things:

1. Ask your lender how close to your payout date you can make a pre-payment and still have that payment count towards reducing your penalty. (Allow several days regardless. You don’t want to cut it too close.)
2. Make the pre-payment and then confirm that your lender has applied it to your account before your lawyer requests the payout statement.  Otherwise, your pre-payment might not reduce your balance for the purposes of penalty calculation.

Variable Rates Quite Relevant, Still

Whenever rate-hike talk starts heating up (like it has since Friday) questions about term selection become more frequent.

People increasingly want to know if the next prime rate increase is their cue to lock in.

The criteria for choosing between a fixed and variable rate have been covered here before, so we won’t bore anyone with repetition (see: Variable or Fixed Rate Mortgage, IDEAS for more on that). 

As any mortgage professional will attest, it’s impossible to make a one-size-fits-all recommendation because the fixed/variable decision is so individual-specific.

What we can do, however, is show how things might shake out from a purely mathematical standpoint if economist forecasts are right (they often aren’t right, but that’s a separate conversation). 

As noted this past weekend, big bank projections imply a 4.50% prime rate by year-end 2011 (see: Long-term Mortgage Rate Forecast). In our own models, we’ve been tacking on another 1/2 point increase as a safety measure, and to reflect what might happen after 2011. Incidentally, the 10-year average for prime rate is 4.72%.

As of July 14, 2010, our current fixed vs. variable model also assumes:

• A highly discounted variable rate (prime – 0.65%)
• A highly discounted fixed rate (3.99%).
• A well-qualified borrower with satisfactory credit, equity, savings, job stability, debt ratios, etc.
• A BoC rate hike pause in early 2011 (to let the U.S. Federal Reserve catch up to the BoC’s overnight rate). 
  
  As usual, rate-change assumptions are based on the projections of major analysts, who presumably have less chance of being wrong than the average Joe.

With these and a few other parameters, one can generate an amortization comparison between a fixed and variable-rate mortgage. That, in turn, can illustrate which of the two hypothetically saves you the most money over five years.

Based on the above assumptions, the variable-rate mortgage comes out ahead of the 5-year fixed, by about $498 over five years for every $100,000 of mortgage. (Sample Analysis)

Therefore, risk-tolerant homeowners (even semi-risk-tolerant homeowners) are potentially doing themselves a disservice by locking in 100% of their mortgage to a long term (like 4 to 10 years).

Granted, there are plenty of caveats. It’s therefore essential to talk things over with a mortgage professional and have him/her run these numbers using assumptions that each of you feel comfortable with.

As well, this article only compares two terms:  a variable and a 5-year fixed. Your mortgage planner, however, might be able to suggest a shorter-term fixed mortgage that is even more preferable than a variable rate.

Suffice it to say, long-term fixed rates haven’t relegated variable rates to irrelevancy, despite the possibility of higher rates right around the corner.  Most strong borrowers should still consider putting at least part of their mortgage in a variable or short-term rate.

RBC Lowers The Ceiling On Its Capped Variable

RBC has significantly reduced the maximum possible rate on its RateCapper mortgage.

The cap is now set at 4.875%. That’s down almost a point since our last review of the product in May (see: RBC RateCapper Mortgage). It’s also one of the lowest maximum rates we can remember on a capped variable mortgage.

If you’re not familiar with this product, the RateCapper is a variable-rate mortgage that limits your risk if prime rate soars. If you were closing today, you’d get a starting rate of prime (2.50%) and the highest your rate would ever go is 4.875%.

A 4.875% cap makes the RateCapper far more appealing to its target clientele—which is, people who fear a large and sustained rate increase, but who also want a low rate in the interim. 

But is it appealing enough? 

After running some amortization simulations we’re left with the conclusion that a deep discounted variable (like prime – 0.60%) is still superior. This example shows the numbers and our assumptions

Our normal model factors in a 250 basis point increase in prime rate over the next couple of years (based on what most major analysts are projecting). For this analysis, however, we’ve assumed a 300 basis point hike (i.e., a 5.50% prime rate by year-end 2011, with flat rates thereafter). 

Based on those assumptions, the regular discounted variable is still less expensive over five years.

If you are still interested in the RateCapper, make sure to have your mortgage advisor run an amortization comparison of the alternatives. It might also serve you well to check out a 3-year fixed.  If you anticipate a moderately large increase in rates, a 3.49% three-year stacks up nicely with the RateCapper.

Getting Approved Before Prices Fall

For the last 4-5 months or more, newspapers have been chock full of headlines like: Are We in a Housing Bubble? 

That’s got many expecting a drop in home prices.

When home prices do fall, it makes it tougher for certain people to qualify for a mortgage—especially for refinances. When prices start dropping, appraisals come in lower, insurer valuation systems become more conservative, and lenders tighten up in general.

Vince Gaetano, a broker with Monster Mortgage, tells the Financial Post that people are already trying to get approved “before there is a correction in the real estate market.”

On that note, here are three scenarios where a small drop in home prices can matter:

• A borrower who wants a line of credit (LOC):
  If the homeowner has 20-25% equity, it may pay to act sooner than later.  That’s because LOCs require a minimum of 20% equity. If your loan-to-value is 75-80%, for example, it only takes a small drop in home values to push you above 80% LTV and keep you from getting approved.
• A borrower wanting to refinance to 90% LTV:
  90% is the maximum loan-to-value for a refinance. Suppose you’re at 85% LTV now and want to roll some high-interest debt into your mortgage. In this case, even a 3% price drop could eat up most of your equity. That could make a refinance not as worthwhile—if at all.
• A borrower looking to refinance to 80% LTV:
  80% is the maximum loan-to-value for uninsured financing (assuming you want the best rates). If your current LTV is in the high 70% range, a small price drop could push you over 80% loan-to-value—requiring that you pay default insurance to get the best rates. Exceptions apply, however, so speak with your mortgage advisor.

Long story short, if you’re in the market to refinance and you think home prices are headed south, it may pay to get your appraisal and approval soon.

Hybrid Mortgages With Free Switches

A client asked us today if we knew of any lenders who allow “free switches” into a hybrid mortgage.  (A hybrid is a mortgage that’s part fixed and part variable, or part short-term and part long-term.)

We composed the list below and thought it might be useful to others. It shows the primary lenders with hybrid mortgages and indicates which of them offer free switches.

• National Bank (has "free switches" into hybrids)
• ATB Financial (has "free switches" into hybrids)
• RBC (has "free switches" into hybrids)
• Scotiabank (refinances only – legal fees apply)
• Laurentian Bank (refinances only – legal fees apply)
• Merix Financial (refinances only – legal fees apply)
• Canadiana Financial (refinances only – legal fees apply)
• HSBC (refinances only – legal fees apply)

If anyone knows of other major lenders offering free switches into a hybrid mortgage, send us a comment below and we’ll add them to the list.

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Side Notes:

• “Free switch” means the new lender will generally cover legal and appraisal costs. That’s opposed to a refinance, where legal fees (and often appraisal fees) apply. The lender losing the mortgage will typically charge the borrower a discharge fee in either case.
• Free switches usually apply only to straight transfers (where there’s no increase to mortgage amount or amortization).
• If your current mortgage has a line of credit attached, you must refinance when changing lenders. Free switches do not apply.

Getting Your Feet Wet With A Variable

When the Bank of Canada expressed uncertainty last Tuesday about the sustainability of our economic recovery, it took rate-hike expectations down a notch.

This, coupled with banks’ reluctance to drop fixed rates (despite widened profit spreads), has shifted some interest away from 5-year fixed mortgages. 

When compared to the average 4.39% 5-year fixed rate, variable rates at prime - 0.60% (1.90%) seem alluring.

We’ve written before about how variables can still make sense for the right kind of borrower (see: Variable & Fixed Mortgage Costs). Yet, as rates start an uptrend, some people just aren’t comfortable without a fixed mortgage…and that’s fine. It’s essential to be confident in your term selection because saving money just isn’t worth it when you get an ulcer in the process.

What many forget (or don’t realize) is that you can always get your feet wet with a variable-rate mortgage, without diving in head-first.  It’s done very easily with a hybrid mortgage.

For instance, if you’re leaning heavily towards a fixed rate, you can instead allocate a small percentage to a variable—say 1/3 for example.

On a $200,000 mortgage, that would give you:

• 66.7% ($133,400) in a 5-year fixed at 4.39% [sample bank rate]
• 33.3% ($66,600) in a 5-year variable at 2.00% [sample bank rate]

If you assumed a 2.50 percentage point increase in prime by year-end 2011 (a common economist forecast), this decision could hypothetically save you about $669 over 60 months with only 33% of the risk of going all-variable.*

Some might ask, “Why not go 100% variable if the odds back variables?”  You can ask the same question about stocks and bonds. History has shown that equities handily trounce bonds long-term. But, just because the odds are good doesn’t mean a 100%-equity portfolio is right for everyone.

People have different pain thresholds when it comes to money. For well-qualified borrowers, however, dipping a toe in the variable-rate pool is often better than not getting in at all.

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*  Assumes a 25-year amortization, a 25 BPS rate increase per Bank of Canada meeting [not a prediction, just an assumption], and stable rates once prime reaches 5%. Consult a mortgage professional to determine suitability before acting on this information. Are you cut out for a variable? See: Choosing Between A Fixed And Variable Rate.

Mr./Mrs. Perfect Broker

Someday we’ll retire, (God only knows when), and we might find ourselves in need of a mortgage.

Hopefully, we’ll be playing so much golf that we won’t have time to keep up on the mortgage market. So, we’ll need to track down a good mortgage planner.

But what would we, as mortgage planners, seek out in a mortgage planner?  We asked ourselves that, and came up with these top 10 criteria.

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Our certain someone would:

1. Be licensed in the industry over two years
   • Experience is so crucial in this business. It just avoids so many headaches. New brokers are very eager to please, but if a newbie is going to make a mistake, better that it be on someone else’s file.
2. Have closed at least $10 million of mortgages in the last 12 months
   • Tenure alone doesn’t afford experience. Deal volume does.
3. Have “status” at a minimum of three lenders
   • For better pricing and faster lender turnaround
4. Know the pros and cons of major mortgage products outside the broker channel (like those from RBC, BMO, and Manulife).
   • So they can advise us objectively.
5. Reply to emails in 8 business hours
   • Who’s got time to wait?
6. Return phone calls the same day
   • Ditto
7. Have a decent professional web presence
   • Brokers who take pride in their marketing are usually fairly competent in other parts of their business
8. Diversify their deal submissions 
   • And not send over 40-50% of their volume to any one lender. Otherwise, their objectivity could be  impaired. (An exception is if they specialize in a mortgage that one particular lender offers.)
9. Recommend the ideal term and explain the reasoning in plain language.
   • And show us a hypothetical amortization comparison to back up that recommendation
10. Get us a rate that’s within 10 basis points of the best available--for the mortgage product we need.
    • We’re always happy to pay for service…but not overpay

Of course, there are many more broker selection criteria that could be added to this list. We’d love to hear yours!

Mortgage Term Review

Here is the very latest mortgage term review, updated to reflect notable rate developments of the past two months.

Variable-rate Adjustment Frequency

When prime rate starts climbing, so will the payments of most variable-rate mortgage holders.

Some people’s variable-rate payments will climb faster than others. That’s because some lenders pass along rate increases quicker than others.

(Note: Things work a little differently for people with fixed-payment variable-rate mortgages. See below.)

Most lenders pass along rate increases as soon as prime rate changes, or on the first day of the following month.  Others give you more time.  ING Direct, for example, only changes its variable rate (for existing customers) every three months. The date of change is based on the borrower’s interest adjustment date. In a rising rate environment, this policy definitely saves some interest.

To see how much interest, we ran a quick scenario.  It compared ING’s rate adjustment policy to the common lender policy of raising variable rates as soon as prime rate increases.

The scenario assumed a $250,000 mortgage, 25-year amortization, 5-year term, a June 1 closing date, and a 2.75% prime rate increase (in 25 bps increments following each BoC meeting).

The results were that ING’s variable saved roughly $540 in interest over the term.  That’s equivalent to saving about five basis points off the interest rate--assuming that rates do rise 2.75% and then average out to no increase/decrease for the remainder of the term.

Mind you, when prime rate eventually falls, this interest effect works in reverse. Yet, given today’s emergency-level 0.25% overnight rate, many would argue that the odds are greater of rates increasing in the next five years than decreasing.

In a nutshell, if you’re getting a variable mortgage today, it’s worth keeping the lender’s rate adjustment policy in mind.

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Sidebar: Some variable-rate mortgages offer a "fixed payment" option. In this case, as rates go up, the payment stays the same, but you pay more interest and less principal. The exception is when rates increase so much that you aren’t paying enough interest each month. In that case, the lender will typically raise your payment or require extra payment to cover the interest due.

Odds & Ends About Insured Rental Financing

CMHC’s new rental mortgage rules have been around for few weeks now.

Here are some of the most common questions we’ve seen people ask about them.

1.  Why are property taxes and heat not factored into debt service calculations on properties that generate rent?

Answer:  When a property generates rent and it is owner-occupied or the subject property of the application, CMHC permits only 50% of that rent to be added to the borrower’s income for qualification purposes. This is referred to as a “50% add-back.”

When calculating total debt service, CMHC does not require property taxes and heat to be explicitly included in the formula. That’s because the 50% add-back method already discounts the rent to take expenses into account.

2.  How can you prove rental income for non-owner occupied rentals owned less than two years?

Answer:  CMHC requires a 2-year history to establish net rental income on non-owner occupied rentals.

When a rental has been owned for less than two years, CMHC permits “the current rent to be used for qualifying purposes if the Approved Lender is satisfied that the rental income is stable.”  To document this rental income, CMHC says lenders can use:

• Audited or review engagement financial statements prepared by a practicing accountant
• Signed leases; or,
• Appraisals containing the reasonable rent rate, and expenses for the rental unit.

3.  Can you borrow the 20% down payment on an insured rental mortgage?

Answer:  CMHC says it generally permits borrowed down payments for non-owner occupied rental properties as follows:

• The down payment must be borrowed against proven assets.
• The proven assets must be “financial in nature, unencumbered by debt, and readily convertible to cash.”

That definition includes lines of credit (LOC) if they are secured by another property the borrower owns. Naturally, any LOC payments must also be factored into the borrower’s debt ratio calculations.

Conversely, borrowing against non-financial assets is not an acceptable way to meet CMHC’s minimum down payment requirements for non-owner occupied properties.

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Don’t forget that lenders have their own policies as well, and they are sometimes more stringent than those above.

For example, not all lenders will let you borrow your down payment on a non-owner occupied rental property.

Suffice it to say, as of April 19 there are a slew of new rental guidelines to be aware of. If you have any questions, you can save a little effort by contacting a mortgage planner. Try to find one that specializes in rental financing to make life easier.

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Sidebar:  For those who haven’t seen them yet, here are CMHC’s debt ratio guidelines for rental properties.

Views On Variables

“Typically a lender’s biggest fear is an informed consumer,” says mortgage planner, Peter Majthenyi. (See this Q&A with Rob Carrick)

That’s because informed consumers are more likely to make choices that are less profitable for lenders.

Going variable is one choice that’s yielding less lender profit these days. For many lenders, gross margins are currently over 20 basis points better in fixed-rate mortgages than in variables.

The big banks salivate at the thought of homeowners paying elevated 4.65% 5-year bank rates. (We’re talking discretionary fixed rates here. The banks’ publically disseminated “special offer” rate is even higher: 4.85%.)

At 4.65%, the average 5-year fixed bank mortgage is 156 basis points over the GoC bond yield (based on Thursday’s close). That’s a succulent spread for a lender. Remember: Five weeks ago, some lenders were selling mortgages at spreads of half that.

Not everyone’s biting, though.

The 2.9 percentage point gap between fixed and variable rates is wide enough to drive a truck through. Informed and well-qualified consumers are therefore comparing today’s fixed rates to prime - .50% variables—and many are taking their chances in a floating rate. 

Here’s what others are saying about variable rates:

• “If you have been in the mortgage for a while, and your mortgage is not as large relative to your income, pay with the variable and you will do better over five years from now, but not significantly.” (CIBC economist, Benjamin Tal)
• “No matter who I am talking to, I ask them to conceive that we are going to see a 3% increase in mortgage rates over the next three years.” (Mortgage planner, Peter Kinch)
• Mortgage planner, Ranjit Dhaliwal, declares variables the mathematical winner, assuming a 3% increase in prime rate (i.e.,  A 25 bps hike every two months for 24 months). (BNN)
• “Borrowers who secured a variable in the last year or so, and are paying prime plus .25% or greater, should strongly consider paying their small discharge penalty and changing to a prime less .5% mortgage immediately” (Mortgage planner, Peter Majthenyi)
• Going variable “is [not] the kind of advice I would give to someone who is fairly well mortgaged up with a debt service rate of 40%.” (Scotia Mortgage Authority’s Jim Smith)
• If you’re well-suited to a variable, “Keep the variable rate, but keep making payments as if [you] were paying a fixed rate.” (Peter Kinch)
• “In the coming months, we are expecting lenders to price variable mortgages at Bank Prime less .25% (or 2%)… so take advantage of the maximum discounts right away.” (Peter Majthenyi)
  
  (This is an interesting call. Most in the industry are expecting variable-rate discounts to remain the same or grow slightly bigger. Peter speculates that spreads will tighten as rates start rising, compelling lenders to decrease discounts. Just today, in fact, we saw one non-bank lender trim their variable discount. On the other hand, some feel that competition will force most lenders to absorb any margin compression and maintain variable discounts.)

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Sidebar:  Professionals endlessly cite Moshe Milevsky’s widely quoted variable-rate research.  They rely on Milevsky’s findings to state that borrowers have saved money in variables 89% of the time over the long-run.

Oddly, those same people rarely quote Milevsky’s updated mortgage research--which showed how the variable-rate advantage falls to 77% when the analysis uses discount mortgage rates instead of posted.

People also ignore Milesky’s warnings that it may be different this time, and that hybrid mortgages are often the most suitable solution of all. See: Fixed or Variable? Updated Perspectives

Important:  Variables are not suitable for everyone, but they’re a sound calculated risk for some. For more decision factors, see: I.D.E.A.S. For Choosing Between A Fixed And Variable Rate)

Words of Warning

Moshe Milevsky is one of the most respected mortgage commentators in the country. A few months ago he had words of warning for those wondering how much home they can afford in Canada’s white-hot real estate markets.

He stated:

“At some point [prices] just become so detached from reality that you have to stop and tell people: ‘you are going to lose money on this deal.’ You have to think very carefully about whether this is the right thing for you.”

“I suspect that what’s driving [record home prices] is the very, very low interest rates. All you have to do is put down 5%, and you can leverage up 19- or 20-to-one. That’s driving this, and I don’t think it’s going to end well for a large group out there.”

Indeed, there are indications that consumer buying power is about to take a tumble once the Bank of Canada starts tightening.

CIBC economist, Benjamin Tal, says:

“The start of the tightening cycle will find a highly leveraged consumer with a debt-to-income ratio approaching a record-high 150%. This is 40% above the ratio seen the last time the Bank of Canada started to hike. This means that monetary policy will be very effective in slowing the consumer.”

A “slowed-down” consumer will spend less on housing and that could put a damper on home prices overall. 

This is just something to keep in mind if you’re contemplating a new home purchase—especially if it’s a bidding war situation and/or you’re putting less than 10% down.

Take it slow. Overpaying makes no sense--regardless of the market. The last thing you want is to experience negative equity and curse the day you put in your offer.

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Sidebar: In case you missed it, here’s BoC governor, Mark Carney’s, thoughts on home prices:  Housing Market Cooling…

Qualifying Rate Now 6.10%

Effective today, the benchmark qualifying rate for insured high-ratio mortgages jumps from 5.85% to 6.10%.

That means it’s now a bit harder to get approved for a variable-rate or a 1- to 4-year fixed term…if you’re putting down less than 20%. 

People choosing those terms will have to prove they can afford monthly payments based on a 6.10% interest rate.

Some lenders—including the big banks--are also applying the new qualifying rate to conventional mortgages with variable and 1-4 year terms.

We talked to brokers about this over the weekend.  The resounding consensus was that this decision will cost banks market share. Many of the banks’ smaller competitors are still using the same qualifying rates on conventional mortgages that they had before the April 19 rule change. That makes it easier for borrowers with 20% down to meet debt service guidelines, and get approved.

Incidentally, there was some confusion this week about when the qualifying rate would be set. Even though the Bank of Canada updates the posted rate every Wednesday, CMHC will set the qualifying rate on Mondays instead (so the rate is consistent for the whole week).

You’ll find the qualifying rate in the left column of this website—updated every Monday.

Analyzing Variable & Fixed Mortgage Costs

Getting the absolute, unequivocal, undisputed rock-bottom best rate creates sheer pleasure for some.

Choosing the best term is usually secondary.

Anyone who understands an amortization table, however, will tell you, without hesitation, that these priorities should be completely reversed.

“Beating the system” and squeezing that extra 0.10% of blood from the lender’s stone is dandy. But it's a Pyrrhic victory if choosing the wrong term costs you 1/2 point.

More:  Analyzing Variable & Fixed Mortgage Costs

Bonds & Fixed Rates

Financial Post (FP) ran a good story last week on the nuts and bolts of mortgage rates, called: Watch Bond Market For Rate Hike Clues

Here are a few of the takeaways:

• 5-year bond yields lead 5-year fixed mortgage rates
• Mortgage rates generally rise at a “one-to-one ratio” with bond yields, according to CIBC economist, Benjamin Tal.
• Bond yields change daily, but not mortgage rates. “Banks will move when they feel the increase is not a one-off thing,” says Tal. Otherwise, it would be too difficult for lenders to quote rates and manage marketing, internal budgeting, forecasting, etc.
• 5-year fixed mortgages (Canada’s most popular term) have historically been priced roughly 120 basis points above the 5-year bond yield.  Lately, however, rabid competition has driven spreads below 75 basis points, as in the case of CIBC’s recent cash-back special.
• FP says there is a 97% correlation between fixed rates and bond yields since 1980, which happens to match our findings from a few weeks ago. 
• “Rates adjust slightly more quickly upwards than downwards,” according to this Bank of Canada study. That’s partly because lenders don’t want to underprice long-term rate holds when rates are rising.
• The good old days (i.e.  March 2010) may be gone for quite a spell... 

“The rates we saw last week, I’d be surprised if we see those again maybe in our lifetime.” – Mortgage planner, Peter Kinch.

Reminder: BFS Rules Change on April 9

CMHC’s new Business for Self (BFS) rules will come into effect on April 9 (prior to the big April 19 rule changes).

If you want to use the older, more liberal BFS rules, you’ll need to have a firm lender approval or (if a purchase) a fully executed purchase agreement by April 8.

This deadline is especially relevant if you’re mortgage shopping and are:

• Paid 100% on commission
• Self-employed and in need of 95% loan-to-value on a purchase
• Self-employed for over three years

These rule changes apply to stated-income mortgages only. If you are self-employed and fully proving your income then you can ignore this post.

Speak to a mortgage professional for complete details.

I.D.E.A.S. For Choosing Between A Fixed And Variable Rate

The first question people often ask when deciding between a fixed and variable mortgage is: “Where do you see rates going?”  

They assume we as mortgage planners know…and of course we don’t.  No one does. 

We can, and do, present a variety of possible rate scenarios based on:

• where we are in the rate cycle
• how rates have performed after past recessions
• and other available research.

But you never know for sure where the rate setters (the Bank of Canada and bond traders) will take the market.

Aside from reading the tea leaves on rates, the best thing a borrower can do is measure his/her ability to handle rising payments. To gauge that, we use a handy acronym called IDEAS.

IDEAS stands for Income, Debt, Equity, Assets, Satisfaction With Risk.

More specifically:

• Income -- Is the borrower’s income stable and reliable?
• Is there a low chance of income interruption?  (You don’t want payments to soar if there’s a chance you’ll be out of a job for a while)
• Does the borrower earn enough to pay his/her variable-rate mortgage as if it were a 5-year fixed mortgage? (i.e.,  Can he/she afford to set his/her payments higher to offset the effect of rising rates?)
• Debt -- Does the client have a reasonable debt ratio?
  • Is the person’s total debt ratio under 40% based on the posted 5-year fixed qualification rate (so that his/her budget isn’t crushed if prime rate jumps to 6.25% or more)?
  • Can the borrower withstand 50% higher payments if rates rocketed up 4%?
• Equity -- Does the client have enough equity?
  • Is the loan-to-value under 80-85% so the person could refinance if absolutely needed?
• Assets -- Does the client have enough assets?
  • Preferably 6 months of living expenses (in liquid assets) to act as a payment buffer if needed.
  • Does the person have a credit line as a backup source of liquidity?
• Satisfaction With Risk -- Can the client accept risk?
  • If rates increase 2.50%, can he/she handle payments rising over 30%? What if rates jump 4%?
  • Does he/she understand that a fixed rate will save him/her more money up to 23% of the time--according to popular research? (Fixed or Variable)

If most, or all, of the answers to the above are affirmative, a variable rate is something the homeowner can entertain.

After evaluating someone against the IDEAS measure, we then discuss (among other things):

• Future interest rate scenarios, and how rising rates could impact payments and amortization time.
• The tools that variable rate holders can use to deal with payment risk, like “hold-the-payment” features (which don’t eliminate payment risk entirely) and hybrid mortgages.
• The pros and cons of relying on a rate conversion (i.e.,  locking in a variable rate)
• The cost comparison of variable versus fixed terms, based on future rate assumptions.

For most people, the decision between fixed and variable will either save them thousands or cost them thousands.  The goal is to try and take as much of the gamble out of the equation as possible.

TD Drops Its 10-Year Fixed To 4.99%

If the fear of rising rates makes your arm hairs stand up, consider this new option from TD:  a 10-year fixed rate of 4.99%.

TD says it’s the bank’s lowest 10-year rate ever.  It’s definitely one of the lowest long-term rates we remember a bank advertising.

On the face of it, 4.99% for 10 years seems like a relative gem for a variety of reasons:

• Fixed rates are almost guaranteed to go higher in the next 12-18 months (Yes, we know, famous last words…). Where they stop, nobody knows.
• Just 15 months ago people were paying over 5% for 5-year mortgages.
• 4.99% is low for even 5-year rates, when viewed over the long term. In the last 10 years, for example, discounted 5-year rates have averaged 5.22%.

So if you want a 10-year term, TD’s offer is compelling.  It's available through both mortgage planners and TD branches.

But a 10-year isn’t ideal for everyone. 

To illustrate, try comparing the obvious alternative:  two successive 5-year fixed mortgages.

If you:

• Get an initial 5-year fixed rate of 3.69%
• Set your amortization to 25-years
• Make the same payments on the 5-year fixed that you would with a 10-year fixed (for the first five years),

…then 5-year rates would have to increase roughly 4% by renewal (in five years) in order for the 10-year fixed to save you more money. 

That’s possible, but if we are to believe that Canada is in an era of modest growth and low inflation, it doesn’t seem overly probable. Indeed, very few economists seem willing to predict 4% higher rates within 60 months.

Whatever the case, ‘safety’ comes at a price and insurance is rarely cheap. On a $200,000 mortgage amortized over 25 years, you’re guaranteed to pay over $12,000 more interest for a 10-year fixed in the first five years.  Is it worth it?  The odds suggest it probably isn’t (see: 10-year Fixed or 5-year Fixed). 

Every homeowner is different though. If you’re unsure about the best term for you, talk to a mortgage professional for a 2nd opinion.

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Sidebar: People hate lender penalties, especially the evil IRD.  One nice thing about 10-year terms is that you can break them after five years with just a 3-month interest penalty.  So if rates are a lot lower than expected in five years, you can refinance at a fairly reasonable cost.

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.

Mortgage Term Review

Here is the very latest mortgage term review, updated to reflect notable rate developments of the past 4 months.