What Rates Could Do to Affordability
Here is a great article on rates and what is expected for the year ahead.
Remember the 10 year term is at the all time low of 3.69% right now!
What Rates Could Do to Affordability
When it comes to home values, mortgage payment affordability acts like a giant lever.
A meaningful rise in mortgage payments (relative to income), would bear down on home prices, and vice versa.
Given this relationship and today’s towering home values, mortgage affordability is centre stage. That has inspired a stream of articles about whether swarms of people will default when rates “normalize.”
But how worrisome is that threat really? For insights, we turned to BMO Capital Markets Senior Economist Sal Guatieri.
To preface everything, here are some data points to consider…
…On Affordability
- According to BMO, home ownership is “affordable” (for the median buyer) when mortgage carrying costs—monthly payments, property taxes, heat, etc.—don’t exceed 39% of family income.
- Nationwide, we’re at about 31.6% today.1
…On Mortgage Payments
- If we look specifically at mortgage payments, BMO says the average-priced house currently consumes 28% of median household income, based on non-discounted mortgage rates.2
- That puts us right at the long-term average (see chart below)
- This 28% falls to 23% for people living outside Vancouver and Toronto.
- Compare these numbers to the peaks of 44% in 1989 and 36% in 2007.
What if rates normalize?
The first step is to define “normal.” We can be reasonably confident that the new normal is less than the old normal. Reasons for that include the long-term downtrend in our domestic growth rate (see chart) and proactive inflation control by the Bank of Canada.
To pump life into the economy, the BoC has kept Canada’s overnight rate at just 1.00% for 902 straight days. According to Guatieri, “A normalized overnight rate would be closer to 3.50% given the inflation target of about 2.00%.”
This implies that short-term rates should theoretically jump by about 2.5 percentage points…someday. In turn, long-term rates (such as 5-year fixed rates) should rise less, maybe 200 basis points says Guatieri. That would push 5-year fixed mortgages somewhere near 4.99%.
Other things equal, these new “normalized” rates would drive up mortgage carrying costs (assuming 10% down) from 31.6% of gross income today to 37.2%. That would still fall below BMO’s threshold of unaffordability, which is 39%. But keep in mind, these affordability metrics don’t include other personal debt like car payments and credit cards.
How will borrowers be affected?
RBC Economics writes, “Residential property values are elevated in Canada and, for many households, ownership remains accessible only because of rock-bottom mortgage rates.”
(Higher incomes have also helped affordability, notes BMO.)
But escalating interest rates aren’t necessarily a death knell. Reason being, “the eventual rise in rates will take place at a time when the Canadian economy is on a stronger footing, thereby generating solid household income gains,” says RBC. That, in turn, “would provide some offset to any negative effects from rising rates.”
The key word there is “some.” Guatieri estimates that, “To fully (our emphasis) offset a two percentage point increase in rates, household income would need to rise 19%, which could take six years if average income grows at the 3% average pace of the past decade.”
Incidentally, for major affordability damage to be done, we’d need something equivalent to a rate shock and/or serious unemployment. A rate shock is a fairly rapid increase in mortgage rates of “more than two percentage points,” Guatieri explains.
How far off is the threat?
It’s difficult to estimate the probability of a rate shock, Guatieri acknowledges. “The debt market is even pricing in a small probability of a BoC rate cut later this year.”
RBC notes, “We expect the Bank of Canada to leave its overnight rate unchanged at 1% throughout 2013 and raise it only gradually starting in early 2014—a scenario posing little in the way of imminent threat.”
Take that rate forecast for what it’s worth, but regardless, “affordability is not a major problem and should not become one even when rates normalize,” Guatieri writes in this report.
That’s true even in three of the fastest growing provinces—Newfoundland, Alberta and Saskatchewan.
The affordability exceptions, not surprisingly, are detached homes in Vancouver, Toronto and Victoria. Not coincidentally, these three markets are among the most prone to the one thing that helps affordability the most: a material price correction.
Footnotes:
1 Based on a 2.99% 5-year fixed rate, property taxes equalling 1% of home value, $150 per month for heating cost, a 25-year amortization, plus fourth-quarter 2012 data provided by BMO, including: Q4 household income estimated at $75,300, an average seasonally adjusted home price of $361,523 and a down payment equalling half of personal income (i.e., $37,600 or ~10%).
2 Same assumptions as above, save for the mortgage rate. BMO uses an interest rate of 4.1% for its analysis. This higher rate makes comparisons easier over the long-run, since discounts were smaller in the past and since discounted rate data from the 1980’s is scarce.
Rob McLister, CMT
Calgary listed as one of the more affordable housing markets in Canada
Great headline for sure. 1 RBC report has 2 articles written about it below.
1.
Calgary listed as one of the more affordable housing markets in Canada
RBC report says city market experiencing a ‘renaissance’
CALGARY — Calgary experienced a housing market renaissance in 2012, reaping the benefits of strong provincial GDP and in-migration, which propelled home resales in the area, says a report released Monday by RBC Economics Research.
The latest Housing Trends and Affordability Report listed Calgary as one of the more affordable housing markets in Canada.
“Calgary-area buyers enjoyed significantly lower home ownership costs as a share of income than they faced at the market peak in early 2007 and the bar fell even further in 2012,” said Craig Wright, senior vice-president and chief economist of RBC. “In fact, it is the only major city in Canada where RBC measures are lower than their historical averages, suggesting that Calgary is one of the more affordable markets in the country.”
Thanks to improvements in previous quarters, all RBC measures stood below their previous-year levels in the fourth quarter. There was some minor deterioration in the latest period, however, with the measure for detached bungalows rising by 0.2 percentage points. But the measure for two-storey homes remained flat, and that for condominium apartments fell by 0.1 percentage points.
The RBC housing affordability measures capture the pre-tax household income needed to service the costs of owning a home at market values.
In Calgary, the average price of a detached bungalow in the fourth quarter of 2012 was $440,600 and the affordability measure was 38.1 per cent. The average price for a standard two-storey home was $434,700 with a measure of 38.6 per cent and for a standard condominium the average price was $250,100 with a measure of 22.2 per cent.
“It’s an exciting time for buyers, borrowing is very affordable right now. I’m seeing this affect the first-time homebuyer and investor market the most lately,” said Shayna Nackoney-Skauge, realtor with RE/MAX Rocky View Real Estate.
“Last week we listed a house that is in relatively original condition in the Varsity area. Within the first eight hours we had 15 showings and two offers. Buyers are flocking to scoop up new competitively-priced listings and investors are quick to pick up well-priced homes for their lot value in high-demand inner-city areas. It’s definitely keeping us on our toes to keep up with what is coming on and off the market on a daily basis.”
RBC said Alberta’s housing market remained vibrant in the final quarter of last year, buoyed by attractive affordability levels, accelerating population growth, a healthy labour market and a strong provincial economy. Although the pace of home resales slowed in the closing months of 2012, the housing market tightened up as fewer properties were listed for sale, it said.
“While homes are not particularly cheap in the province, Albertans boast the highest household incomes in Canada, which helps ensure that the share of their budget taken up by home ownership costs is easily manageable,” said Wright. “Barring an unexpected shock to the economy, housing market conditions in Alberta should remain positive in 2013.”
The RBC housing affordability measures for the province fell across all three housing types tracked by RBC. RBC’s measures for the benchmark detached bungalow and the standard two-storey fell by 0.2 percentage points to 32.1 per cent and 34.7 per cent, respectively. The measure for condominium apartments fell by 0.1 percentage points to 19.7 per cent. Average prices were: bungalow, $357,900; two-storey, $378,800; and condo, $213,300.
Nationally, affordability measures dropped by 0.2 percentage points for both bungalows (42.1 per cent) and condos (28.0 per cent) and by 0.3 percentage points for two-storey homes (47.8 per cent). Average prices in Canada in the fourth quarter of 2012 were: bungalow, $363,400; two-storey, $410,600; and condos, $237,600.
Twitter: MTone123
© Copyright (c) The Calgary Herald
2.
Low mortgage rates muster slight boost in housing market affordability
TARA PERKINS – REAL ESTATE REPORTER – The Globe and Mail
PublishedMonday, Feb. 25 2013, 5:00 AM EST
Owning a house became slightly more affordable in Canada during the second half of 2012, but that’s mostly due to rock-bottom mortgage rates, RBC Economics says in a report to be released Monday.
The sharp drop in house sales that occurred during the final six months of the year led to some small month-over-month declines in house prices in many cities. And, as sales fell, banks made further small cuts to their already-low mortgage rates. Those two factors helped to take a tiny bite out of the cost of home ownership during the final three months of the year, for the second quarter in a row, RBC says.
The report comes as economists debate the health of the housing market and whether the moves that Ottawa made to tighten the market last summer will continue to have an impact this year.
On Friday, BMO Economics said that the latest data suggests falling mortgage rates and rising incomes are offsetting the effects of high house prices in most markets. That report said that affordability is not a “major problem” in most of the country, including Toronto’s much-watched condo market, and that it should not become one even when rates hit more normal levels.
“If interest rates remain low, income continues to rise, and prices stabilize this year – as we anticipate – fears of a deep housing correction should recede,” BMO senior economist Sal Guatieri wrote in that report. But he urged policy makers to “remain vigilant,” pointing to a number of major exceptions, namely the markets for detached homes in Vancouver, Toronto and Victoria, each of which are vulnerable to a significant correction if incomes fall or rates rise.
Finance Minister Jim Flaherty made changes to the mortgage insurance rules in July, after growing concerned that house prices and household debt levels were rising too fast. Those changes, which made it somewhat harder to obtain a mortgage, included cutting the maximum length of an insured mortgage to 25 years from 30 years.
“We expect overall housing market activity to remain subdued this year,” says RBC chief economist Craig Wright. “That said, we believe that there is scope for some mild strengthening from recent activity levels, as the negative effects of the mortgage insurance rule changes, implemented in July, 2012, gradually dissipate.”
While affordability is improving, RBC is warning that many families could be priced out of the market if interest rates were to jump.
“Exceptionally low interest rates have been the key factor keeping home affordability from reaching dangerous levels in recent years,” says Mr. Wright. “Residential property values are elevated in Canada and, for many households, ownership remains accessible only because of rock-bottom mortgage rates.”
BMO’s report suggests that, nationwide, Canada’s housing market is overvalued by about 10 per cent.
RBC’s housing affordability measure calculates the proportion of pre-tax household income that is required to service the costs of a house at current market prices. Both detached bungalows and condos saw the measure fall by 0.2 percentage points (to 42.1 per cent and 28 per cent respectively), while the measure for a two-storey home fell by 0.3 percentage points to 47.8 per cent.
All of the measures remain slightly higher than their historical averages, but the national figures are being propped up by “extremely poor affordability conditions” in the Vancouver area, RBC says.
Roughly 82.2 per cent of pre-tax income was required to service the cost of a detached bungalow in Vancouver during the final quarter of 2012, down 2.6 percentage points from the prior quarter, RBC says. Toronto’s measure was 52.8 per cent, down 0.4 percentage points; Montreal was 39.3 per cent, down 0.9 percentage points; Ottawa 38.8 per cent, down 0.5 percentage points; and Edmonton 30.7 per cent, down 0.1 percentage points. In Calgary, where the market is on an upswing, the measure was 38.1 per cent, up 0.2 percentage points.
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.