Tax Freedom Day was June 11th!
First posted: Tuesday, June 12, 2012 06:46 PM MDT | Updated: Tuesday, June 12, 2012 07:59 PM MDT
The federal government expects a deficit of $21 billion this year. (Chris Roussakis/QMI Agency)
If you’ve ever tried to calculate all the taxes you pay in a year to all levels of government, you’ve probably given up somewhere along the way.
While most of us can easily decipher how much income tax we pay — it’s right there on our tax returns — it’s a lot more difficult to gauge how much we pay in not-so-obvious taxes.
For Canadian families to reasonably estimate their total tax bill, they’d have to add up a dizzying array of taxes, including visible ones like income taxes, sales taxes, social security taxes and property taxes, as well as hidden ones like profit taxes, gas taxes, alcohol taxes … and the list goes on.
This is no easy task.
That’s why the Fraser Institute calculates Tax Freedom Day every year.
Tax Freedom Day is an easy-to-understand measure of the total tax burden imposed on Canadian families by federal, provincial and local governments.
If Canadians were required to pay all taxes up front, they would have to give governments each and every dollar they earned prior to Tax Freedom Day.
In 2012, we estimate the average Canadian family consisting of two or more people will earn $94,258 and pay a total tax bill of $41,627, or 44.2% of income.
Tax Freedom Day fell on Monday, June 11 this year.
From then on, Canadians start working for themselves and their families, rather than the government.
While that alone is reason to celebrate, you may want to keep the champagne on ice because the good news ends there.
Tax Freedom Day arrives one day later than last year. There are two main reasons.
First, several Canadian governments have raised taxes, from increased Employment Insurance premiums at the federal level, to a higher provincial sales tax in Quebec, to increased health taxes in B.C. and a new tax on high earners in Ontario.
Second, Canada’s economy is still recovering from the recession and as incomes continue to increase, a family’s tax burden increases to a greater extent because of Canada’s progressive tax system, which imposes higher taxes as Canadians earn more money.
For instance, the top fifth of income earners face an average total tax burden amounting to 54% of income, while the bottom fifth face an average burden of 18%.
There’s more bad news.
The federal and almost all provincial governments are running deficits this year. (Ottawa expects a deficit of $21 billion, while the provinces cumulatively expect deficits amounting to $20 billion).
According to our calculations, Tax Freedom Day would come 12 days later this year (June 23) if Canadian governments covered their current spending with even greater tax increases, instead of borrowing the shortfall as debt.
It’s important to remember budget deficits incurred by Ottawa and the provinces must one day be paid for by taxes.
With the recent significant growth in government debt across the country, Tax Freedom Day could come later in the future. By kicking today’s debt down the road, governments are passing on the burden of repayment to young Canadian families.
It is ultimately up to Canadians to decide whether June 11 is an acceptable Tax Freedom Day.
On that note, happy Tax Freedom Day, although maybe “happy” isn’t the right word.
— Palacios and Lammam are economists with the Fraser Institute and co-authors of Canadians Celebrate Tax Freedom Day on June 11, 2012, available at www.fraserinstitute.org
Is there ever a bad time to invest in a rental property?
Fabio Campanella, Special to Financial Post May 22, 2012 – 10:48 AM ET
Record low interest rates coupled with an overly extended bull market for Canadian residential real estate has some investors questioning the validity of investing in a rental property.
Current economic indicators support these fears: mortgage rates scheduled to rise, a global economy not yet out of the recessionary trenches, residential real estate prices in Canada that have clearly outpaced increases in general earnings over the last decade.
This all paints a compelling picture supporting the hesitation some investors have when dealing with rental properties. But is this hesitation legitimate? Is there ever really a good or bad time to get into the real estate rental market? The answer is yes, and also no; it all depends on your current financial situation.
If the Toronto residential market is used as a barometer we can see that residential real estate has treated us quite well over the past 20 years. During the period from 1992 to 2011 the average sale price for a home in Toronto increased from $214,971 to $465,412 according to the Toronto Real Estate Board (TREB).
That’s a 116.50% ROI over 20 years or 3.94% compound annual return, and that’s just the price increase not including any potential rental profits. In fact, over the last 20 years we have only seen four years of negative returns in the Toronto market and they all fell between 1992 to 1996.
Assuming you were to have purchased an average single-family Toronto rental property in 1992, put 25% down, taken a mortgage for the rest, and found a tenant who’s rental payments covered only your property’s basic operating expenses, taxes, maintenance and the interest portion of your mortgage (leaving you to cover the principal portion yourself) you’d have achieved an 11.40% annualized return on investment as at the end of 2011.
Not bad considering that the TSX would have given you 8.69% over the same time period. Using the same assumptions in the previous example on rolling 20-year periods from 1966 to 2011 the average investor would have achieved annualized compound returns of 13.96%.
In fact even if you were to have purchased a property at the bull market peak just before the infamous GTA real estate crash of 1990 you would still have achieved an 8.94% ROI if you held the property with a decent tenant until 2008 even though the value of your investment would have dropped by 25% over the first 4 years.
So what’s the point? Are rental properties a good investment and is this the right or wrong time to make a move? The answer is yes but only if you’re in it for the long-haul and only if your current financial position allows you to do so. Novice investors tend to follow market momentum and stretch themselves thin. They see prices increasing year over year then go out and take massive amounts of leverage to get in on the action “before it’s too late.”
What often happens is they buy more than they can handle, they don’t do proper due diligence on their tenants, and they get caught with a dud investment that they can’t support with their personal cash flow. This frequently leads to panic selling in order to raise funds to pay off large amounts of debt consequently resulting in losses.
Smart investors take their time. They seek out properties in desirable neighbourhoods, scrutinize their tenant’s ability to make rent payments before they take them on, manage the property with a keen eye, but most importantly they do not over-extend their leverage. Smart investors realize that there may be times that tenants can’t make rent or that markets may temporarily turn south.
Even if the original intention for a real estate investment is a short term flip, the smart investor will not purchase a property they aren’t able to hold over a long period of time should price momentum not go their way in the short run.
Direct investment in real estate is not like buying a passive investment such as a mutual fund. It requires a time commitment, experience, and patience but the long-term results can be superb when done properly.
Fabio Campanella CA, CFP, CIM is a partner at Campanella McDonald LLP. Fabio@CampanellaMcDonald.com
Why putting less than 20% down can lead to a better mortgage rate
This is true – the banks are sending us 2 rates … 1 rate for a CMHC/ Genworth insured mortgage and a slightly higher one for more than 20% down – or a conventional mortgage that is not insured.
The article below fully explains why.
By Garry Marr, Financial Post May 3, 2012
It doesn’t make much sense, but a skimpy down payment on a home might actually get you a better mortgage rate in today’s market.
Blame the government subsidy known as mortgage default insurance, which ultimately makes it less risky to lend money to someone who has only 5% down compared to someone with 20%.
Consumers with less than 20% down must get mortgage default insurance in Canada if they are borrowing from a federally regulated bank. The cost is up to 2.75% of the mortgage amount upfront on a 25-year amortization but that fee comes with 100% backing from the federal government if the insurance is provided by Crown corporation Canada Mortgage and Housing Corp.
“It’s already happening,” says Rob McLister, editor of Canadian Mortgage Trends, who says secondary lenders are now offering rates that are 10 to 15 basis points higher for a closed five-year mortgage for uninsured consumers.
The crackdown on mortgage insurance announced by Jim Flaherty, the federal Finance Minister, could exacerbate the situation. Mr. Flaherty, who mused to the Financial Post editorial board last week about getting CMHC out of the mortgage insurance business, has placed the agency under the authority of the country’s banking regulator, the Office of the Superintendent of Financial Institutions.
Mr. Flaherty also put in new rules on bulk or portfolio insurance. The banks had been paying the insurance premium on low-ratio mortgages – loans with more than 20% down – because it was easier to securitize them.
However, Mr. Flaherty says those loans will no longer be allowed in the government’s covered bond program.
“Long story short, it is going to tick up rates to some degree,” Mr. McLister says. “You are seeing an interesting phenomenon where if you go to get a mortgage today, you are oftentimes quoted a higher rate on a conventional mortgage. Presumably you have less risk because you have more equity.”
“There is a question on whether they will continue doing that or raise rates overall to compensate for higher conventional mortgage costs,” Mr. McLister says.
“When we can’t securitize a deal, there is a different cost of funds but the bank continues to offer the same rate,” said Ms. Haque, adding her bank did charge a premium for stated income deals, which usually means self-employed people, but removed the difference last week. The premium was 20 basis points.
“Looking at the competitive landscape, it was a disadvantage,” she says. “We were aiming to target pricing that was specific and for the risk appetite for that deal itself. We didn’t want one [deal] compensating for the other.”
But the banks have bigger fish to fry than just your mortgage. Those with the larger equity position in their homes may be a costlier mortgage to fund, but they also could be a future line-of-credit customers. There’s also the potential for other business such as RRSPs and TFSA, so losing a few basis points might make more sense in the long run.
Peter Routledge, an analyst at National Bank Financial, says he wouldn’t want to be an investor in a bank that approached its business any other way, though he did acknowledge there is a cost to keeping those conventional mortgages. “It’s in effect a subsidy,” Mr. Routledge says.
While banks may be eating some of the costs for people who are not eligible for a subsidy, if they continue down that road they might not be able to match the rates some of the secondary lenders are able to offer with insured mortgages.
It doesn’t sound like much, but the difference between, say, 3.14% and 3.29% on a $500,000 mortgage amortized over 25 years would be about $3,500 extra in interest on a five-year term.
It’s true that those people getting the better rate pay a hefty fee up front in insurance premiums, but they also represent a greater risk to the taxpayer. Do they deserve a better rate?
Interest Rates to go up soon – the boring data
Carney raises outlook for economy, issues dollar warning
At a news conference in Ottawa after releasing his forecast, Mr. Carney seemed to employ a tactic known as “jawboning,” used when officials try to cool speculators’ enthusiasm for the dollar (CAD/USD-I1.01-0.0005-0.05%), saying that trading the currency as if it will always rise in tandem with global oil prices (CL-FT102.74-1.46-1.40%) is a “recipe for losing money.”
While it is not clear Mr. Carney was indeed trying to bid the currency down, his forecast assumes the loonie will trade above parity with the U.S. dollar until 2014, and reiterates that the strength of the currency is hurting exporters’ competitiveness. Moreover, the forecast included an analysis showing that lately, high oil prices have not been as much of a bonus for the economy as in the past.
“It is far too simplistic to talk about the Canadian dollar as a commodity currency, let alone a currency that moves consistent with one commodity,” Mr. Carney told reporters. “And to trade or to invest in the currency along those lines, ultimately over the medium term, it’s going to be a recipe for losing money. So, this is a much more diverse, complex economy than that, and this is one manifestation of it. We’re not going to give advice on how people should trade in the markets, but it’s important to point out the underlying dynamics.”
On one level, Mr. Carney was just stating reality, as he points out that there is more to Canada’s economy than oil. Another big factor in the loonie’s strength is the fact that investors are drawn to the country’s stocks and bonds, too. But Mr. Carney also has a stake in trying to unhinge the loonie from high oil prices, since putting a brake on the currency will make it easier for him to raise borrowing costs as the economy strengthens, without making life harder for exporters.
The comments came a day after Mr. Carney hinted for the first time since last summer that he is beginning to look for an opportunity to raise his benchmark interest rates from the current 1 per cent, where it has been since September, 2010. (On Tuesday, the loonie shot up almost a full cent against the greenback in response to the mere talk of rate hikes.) The central bankers expanded on Tuesday’s interest-rate decision, in which they indicated that, on balance, the slack in the economy is vanishing more quickly than thought, and as a result, rate hikes “may become appropriate,” depending how events play out. Perhaps to limit expectations for an aggressive tightening campaign, Wednesday’s forecast suggested challenges like the currency, record levels of household debt, a still relatively weak labour market and lofty oil prices will complicate the path to higher rates.
The outlook for Canada is undeniably improved from the bank’s January forecast, as the U.S. recovery gains strength and the euro crisis looks more stable, boosting confidence among Canadian consumers and companies. The economy will grow at an annual rate of 2.5 per cent in each of the first two quarters, 2.4 per cent in the third and 2.5 per cent in the fourth. That compares with the central bank’s January calls of 1.8-per-cent growth through the first half of the year, 2.1 per cent in the third quarter and 2.6 per cent in the final three months of the year.
At the same time, the bank’s 2013 forecasts for the economy were pushed down.
“With confidence having rebounded more quickly than envisaged in January, the bank expects that global uncertainty will have less of a dampening effect on the spending of Canadian households and businesses,” Mr. Carney and his governing council said in their Monetary Policy Report. “The profile for growth in consumption and investment is more front-loaded than previously expected.”
The central bank also raised its forecast for the U.S., Canada’s chief export market, for 2012 and 2013, to 2.3 per cent and 2.5 per cent, and said the euro zone will grow 0.8 per cent in 2013 as it recovers from a smaller-than-previously expected downturn this year.
Still, though Tuesday’s rate statement reminded investors and overstretched consumers that the central bank will not be gun-shy about raising rates before the middle of next year if it deems that necessary to meet its 2 per cent annual inflation target, the forecast contained hints that it will tread very cautiously.
For instance, the bank continues to see high household debt as the No. 1 domestic risk, so even as Mr. Carney has indicated that he would be willing to use monetary policy as a last resort to tame consumer behaviour, he knows that higher rates could tame consumer borrowing too abruptly. In the forecast, policy makers included an analysis warning that Canadians are borrowing too much through home-equity lines of credit, making them “more exposed” to a drop in house prices which, in turn, could “dampen consumption.” And consumption is forecast to make up more than half of the private-led demand that will drive growth over the next couple of years.
The bank’s analysis of oil prices said that, starting in January, they have evolved in a way that “has been unfavourable to Canada,” mainly because the price of oil the country imports (tied to Brent North Sea crude) has risen while the price of what the country’s energy companies sell abroad (tied to West Texas Intermediate) has dropped. This, the bank said, is in part due to the glut of product in the U.S. that new pipeline projects are supposed to alleviate.
“The increase in the price of our oil imports raises production costs for Canadian firms and also puts upward pressure on gasoline prices,” the bank said. “The price differential between WTI and Brent is expected to persist for some time, however, until new pipeline capacity is put in place in the United States and Canada to reduce the excess supply situation at Cushing, Okla.”
More problems with collateral mortgages
Here is more bad news on collateral mortgages.
People refuse to sign a 3 year cell phone contract but then for some reason have no problem in losing every single thing you have ever made and be sued into bankruptcy by your bank for taking one of these mortgages. Again, we do not offer them but TD, Scotia, ING, and RBC have them as STANDARD. I would rather take a new 3 year cell phone contract!
Beware the pitfals of collateral mortgages
By Mark Weisleder | Sat Jul 30 2011
When you apply for a mortgage, you usually just ask about the term, amount, interest rate and monthly payment. Not many people understand the difference between a conventional mortgage and a collateral mortgage. Yet many banks are now asking borrowers to sign collateral mortgages — and it could result in them being tied to this bank, for life.
With a normal conventional mortgage you bargain for a set amount, rate and amortization. Say the property is worth $250,000 — you bargain for a $200,000 loan, at 3.5 per cent, a five-year term/25-year amortization, payments of $998.54 per month.
A conventional mortgage is registered against the property for $200,000. If all the payments are made on time, the mortgage is renewed on the same terms every five years and no prepayments are made, the balance is zero after 25 years.
Should another lender decide to lend you money as a second mortgage, there is nothing stopping them from doing so, subject to their own guidelines. Under normal circumstances the principal balance on a conventional mortgage goes only one way, down. In addition, banks will accept “transfers” of conventional mortgages from other banks, at little or no cost to the consumer.
A collateral mortgage has as its primary security a promissory note or loan agreement and as “backup,” a collateral security, being a mortgage against your property. The difference is that, in most cases, the mortgage will be for 125 per cent of the value of the property. In our example, the mortgage registered will be for $312,500. But you will only receive $200,000. The loan agreement will indicate the actual amount of the loan, interest rate and monthly payments.
The collateral mortgage may indicate an interest rate of prime plus 5-10 per cent. This will permit you to go back to this same bank and borrow more money from time to time, without having to register new security. The lender will offer you a closing service, to register the mortgage against your property, at fees that will be cheaper than what a lawyer would charge you. Sounds good so far, doesn’t it?
However, this collateral loan agreement has different consequences, which are usually not explained to the borrower.
• Most banks will not accept “transfers” of collateral mortgages from other banks, so the consumer is forced to pay discharge fees to get out of one mortgage and additional fees to register a new mortgage if they move to a new lender. Thus the bank is able to tie you to them for all your lending needs indefinitely because it will cost you too much to move.
• Lenders may be able to use the collateral mortgage to offset any other unpaid debts you have. Offset is a right under Canadian law that says a lender may be able to seize equity you have in your home, over and above the mortgage balance, to pay, for example, a credit-card balance, a car loan, or any loan you may have co-signed that is in default with the same lender. In essence any loans you may have with that lender may be secured by the collateral mortgage. Nobody goes into a mortgage thinking about default, but “stuff” happens in people’s lives and 25 years is a long time.
• Let’s say your house value is $200,000. A collateral first mortgage registered on the property is $250,000. The amount owing on the mortgage is $150,000. If you were to need an additional $20,000, but the lender declines to lend it for any reason, then practically speaking you won’t be able to approach any other lender. They will not go behind a $250,000 mortgage. Your only way out would be to pay any prepayment penalty to get out of the first mortgage and pay any additional costs to get a new mortgage.
• Let’s say your mortgage is in good standing but you default under a credit line with the same bank. The bank could in most cases still start default proceedings under your mortgage, meaning you could lose the house.
• Some lenders are offering collateral mortgages in a “negative option billing” manner. Unless you are informed enough to say you want a conventional mortgage, you will be asked to sign documents for a collateral mortgage.
I spoke with David O’Gorman, the president and principal mortgage broker with MortgageLand Inc. He tells me it is his duty under the law to ensure the “suitability” of any mortgage he arranges for a consumer.
He would be hard pressed to justify the recommendation of this type of collateral first mortgage to any consumer, without disclosing both verbally and in writing the points listed above, and he believes the consumer should have their own lawyer review everything before they sign.
Lending money to people without proper explanation of the consequences is wrong. The banking regulators need to look into this practice and stop it. In the meantime, do not sign any mortgage document without discussing it first with your own lawyer.
Collateral Mortgages Part II: Why Banks Like You to Have Them.
Collateral mortgages: Why banks like them
Collateral mortgage can be a great product for homeowners who use their homes to borrow and invest. But compared to a conventional mortgage, it is harder to transfer to another bank at the end of your term.
If you’re buying a house and are shopping for a mortgage this spring you may come across something called a collateral mortgage. This home financing tool has been around for a while, but mainly in the background. Now it’s going mainstream with both TD Bank and no-frills ING Direct abandoning the conventional mortgage in favour of this type of financing exclusively. Other big banks make collateral mortgages available, but for now offer both kinds.
Many consumers hunting for a mortgage would be hard pressed to explain the difference between the two, but here it is:
With a conventional mortgage, you and your lender agree on how much you can borrow, the length of the term and the interest rate. As an example, say the house you’re buying is worth $200,000. With 20 per cent down you would borrow $160,000. You might select a fixed-rate, five-year term, which this week is between 3 and 4 per cent.
With a collateral mortgage, you still have an agreed interest rate and term, but the bank registers a charge of up to 125 per cent the value of your home, provided you have at least 20 per cent equity in it. In this example the charge would be $200,000 plus up to another $50,000.
That’s because a collateral agreement assumes you will want to borrow more in the future and so makes this extra amount available now. As long as you maintain 20 per cent equity in your home, you borrow up to 80 per cent of its value.
So a collateral mortgage can be a great product for homeowners who want that extra borrowing ability along with their mortgage. Doing all the paperwork while applying for the mortgage saves fees that would apply later if a homeowner tried to apply for a credit line.
Related: Beware the pitfalls of collateral mortgages
The advantage to the bank is that a collateral agreement makes it harder for you to leave because it interlocks your lending. As Toronto real estate lawyer Mark Weisleder, a Moneyville columnist, points out, a collateral mortgage secures all debt held with that lender under one agreement. So a line of credit, a credit card, car loan or any personal loan will all be secured by the same agreement.
Most banks do not allow transfers of collateral mortgages because they are tied to other consumer loans. This means that at the end of your five-year term, you have to pay discharge fees to get out of one mortgage and additional fees to register a new one at another financial institution. On the other hand, a conventional mortgage is easy to transfer when the term is up.
Another difference is that in a conventional agreement your rate cannot be increased during the term, even if you default or fall into arrears with your payments.
With a collateral mortgage, if you go into arrears or default, the bank has the right to raise your interest rate by up to 10 percentage points.
This is because a collateral mortgage is registered at a charge of prime plus 10 per cent. Senior TD Bank mortgage official Farhaneh Haque says the this higher rate is charged to protect customers from incurring more legal and administration fees when they want to borrow more. Without this, the bank would have to reregister the loan when you want to borrow more. Since the loan is already registered at this higher rate, when you qualify, the bank can offer it to you with no questions asked, even if the loan is 10 points higher.
Tom Hamza, president of Investor Education Fund, a consumer agency funded by the Ontario Securities Commission, says it’s clear why collateral agreements are attractive to the banks.
“The fact that people can access money more easily and the fact that they won’t leave are two pretty compelling reasons for financial institutions to offer these,” he says.
Hamza says collateral mortgages are good for homeowners who have a lot of debt in a lot of different places, or those who “frequently need to access to cash”. But for all others it may not be the right product.
If you don’t want the extra money and want the freedom to move your business elsewhere when the mortgage matures, a collateral agreement is probably not the best option. It’s a classic case of buyer beware, before you sign up for a collateral agreement make sure it’s the product that suits you and your lifestyle.
Why We Know: Prime should stay the same for 2012 @ 3%
Below is a sample of a very boring statement about a prediction on why Prime should stay at 3% for the rest of 2012. Prime and fixed rates “tend” to move together but not always and fixed rates went up on March 27th due to other factors.
All this really says is …. let us watch this “raw mortgage data” for you. This is all we do all day and why we are able to give you the best, unbiased advice on mortgages we can.
Canadian business sentiment brightens: BoC survey
By Louise Egan
OTTAWA (Reuters) – Canadian business sentiment on future sales rose to its highest level in two years in the first quarter, and companies also expect to increase investment and hire more staff, the Bank of Canada’s spring survey showed on Monday.
The survey also found that the percentage of companies that see the inflation rate at between 2 and 3 percent, the upper end of the central bank’s 1-3 percent target range, rose to 63 percent from 51 percent, the most since 2007.
However, other indicators showed little pressure on inflation. Businesses reported some easing of capacity pressures, contrary to analysts’ expectations, and slightly fewer had labor shortages.
The percentage reporting that they would have some, or significant, difficulty meeting an unexpected increase in demand fell to 39 percent from 46 percent in the bank’s winter survey.
“Some firms, notably those in the services sector, reported that they could accommodate higher demand because of earlier investments to expand capacity or because they have flexibility in adjusting the scale of their operations,” the bank said in its release.
Market players watch the survey data for clues about the Bank of Canada’s next interest rate move. The bank has sounded a bit more hawkish in recent statements, prompting talk of a rate hike this year rather than next, as most analysts have forecast.
“Overall, the firmer growth expectations fit well with other recent surveys, but the tame inflation readings should leave the Bank of Canada in no hurry to start tightening just yet,” said Avery Shenfeld, chief economist at CIBC World Markets.
While business sentiment on inflation and sales could add pressure on the bank to raise rates, the easing of capacity pressures suggests there is no rush to do so.
The upbeat view on sales was the most marked change in the survey, in which the bank conducted interviews with senior managers at 100 companies from February 21 to March 15.
Fifty-eight percent said they expected sales to grow at a faster pace in the next year than in the past year, versus 37 percent who expected that in the December-January period.
The balance of opinion – the percentage of companies expecting faster growth minus the percentage expecting slower growth – rose to 22 from -4 previously. That was the best showing since the first quarter of 2010.
The bank’s next rate announcement is April 17, followed by its quarterly economic projections the next day.
It has held its key rate unchanged since at 1.0 percent since September 2010, and primary securities dealers forecast, on average, no change until the third quarter of 2013.
Overnight index swaps, which trade based on expectations for the policy rate, show traders slightly lowered their bets of a possible rate hike this year following the release of the Bank of Canada’s surveys.
A separate survey of senior loan officers showed overall lending conditions eased for businesses in the first quarter.
(Reporting By Louise Egan; Editing by Peter Galloway and Janet Guttsman)
© Thomson Reuters 2012 All rights reserved.
The upside of higher rates
We all know interest rates are going to go up. Even after reading this the big hit we all know is coming is that variable rate mortgage payments go up right away. The rest mentioned below may come later.
Jason Heath Mar 31, 2012 – 7:00 AM ET | Last Updated: Mar 30, 2012 9:09 AM ET
For three years, the word on the street has been that interest rates have nowhere to go but up. But few Canadian commentators – other than David Rosenberg – got the call on rates right. Although the prime rate has risen since dropping to an all-time low of 2.25% in April 2009, the increase to the current 3% rate that has remained stable since September 2010 has been modest to say the least. Long-term rates, like fixed mortgage rates, have gone up and come back down during that time, such that one can currently lock in fixed rates under 3%.
York University’s Moshe Milevsky did a study in 2001, which he revised in 2007, and determined that borrowers are better off going with a variable rate mortgage instead of a fixed rate mortgage approximately 9 times out of 10. That said, we have to be close to if not already in that 10% sweet spot where fixed beats variable.
Despite the opportunity to lock in low rates today, it could actually be beneficial for the average Canadian for rates to rise. Conditions need to warrant rate increases and the Bank of Canada (which directly governs the prime rate) and the bond market (which indirectly governs fixed mortgage rates) won’t raise rates until the time is right. How soon that time comes depends partially on domestic influences, but also on our neighbours to the south and the current eurozone debt debacle.
Greece is a perfect example of why rates should rise. Greek participation in the European Union gave them access to cheap credit and helped facilitate some of the excess spending that has them where they are today. Despite bond markets demanding higher interest rates on Greek and some other European government bonds, market intervention by the EU has helped keep rates artificially low.
The U.S. Federal Reserve has been doing the same thing, buying up U.S. government treasury bills to keep U.S. rates artificially low as well.
It’s hard to justify how artificially low interest rates for an extended period are good for anything other than delaying the inevitable for some market participants.
Higher rates would have a negative impact on those of us with outstanding debt, as higher interest charges would follow. But Canadian debt levels have moved ever higher in recent years, likely a response to the low rates that have been in place in part to stimulate spending. Higher mortgage rates could protect us from ourselves by making higher debt levels more punitive and less tempting.
Furthermore, fixed income investors could benefit. The emphasis on “could” is key. Rising rates typically hurt those holding bonds because today’s bonds are that much more appealing than yesterday’s as rates go up. How much the hurt hurts is a matter of fact. But those renewing GICs or sitting on cash these days are desperately awaiting higher interest rates to help their savings grow. So higher rates could at least lead to higher returns for fixed income investors in some cases.
Higher rates could benefit stock investors. Once again, the emphasis on “could” is key. Higher rates usually mean the economy is improving and inflation is rising. This could be a good sign that corporate profits and corresponding stock prices are moving higher. That said, one has to wonder if low bond and GIC interest rates and cheap credit have pushed more money into the stock market than should otherwise be there. Rising rates could bring income investors back to the more traditional income investments like bonds and GICs from the blue chip stocks they’ve potentially flocked to in order to obtain yield.
Despite the purported uncertainty above on stocks and bonds, higher rates should at least contribute somewhat to restoring equilibrium to credit, debt and equity markets. Something seems wrong with near zero or negative real interest rates. That is, something seems wrong with a GIC investor earning 2%, paying 1% of that away in tax and 2% inflation resulting in an effective return of -1%. On that basis, something seems right about higher interest rates, whether we like it or not. What happens to mortgage debt, stocks and bonds remains to be seen.
Jason Heath is a fee-only Certified Financial Planner (CFP) and income tax professional for Objective Financial Partners Inc. in Toronto.
Mortgage Market Commentary
Mortgage Market Commentary:
With the federal budget fading into the past the question, as always, becomes “what’s next”. The answer seems to be focused on “interest rates”. It seems inevitable that they will rise from their current historic lows. So the next question become: when, by how much, how fast and – given the ongoing concerns about household debt – what will happen.
The U.S. Federal Reserve has made it clear it intends to hold its benchmark rate at near zero into 2014. But popular thinking among economists is that the Bank of Canada could move sooner but not until Q1 2013. The risk of inflation is the biggest deciding factor now.
Short and sweet.