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
Possible Mortgage Rate Increase from these 112.7 year lows?
We are able to watch some indicators that drive mortgage interest rates. This is how we can guess what rates are going to do over a 10 day or so period.
Right now the spread on Canadian 5 year mortgage bond is 1.795%. This is WELL BELOW the comfort zone of 1.90% and 2.10%. Can we potentially see a rise in interest rates?
Hard to say as the spread has be bouncing all over the last few days, but it could trigger a small rise in rates if it does not bounce back soon.
What does this mean?
- If you are going to buy a home, or are planning on moving up or
- have a mortgage that is up for renewal in less than 120 days from now, or know someone who does, then
- CALL for a rate hold at today’s super low rates ASAP. We answer the phone from 9 am to 10 pm every way, holidays and weekends included.
Other Key Points about Mortgage Brokers:
- We have access to all the banks.
- The banks pay us for doing their work for them so there are no fees to clients for our services.
- The rates and terms & conditions are better than the Big 6 offer.
- We offer unbiased, expert advice; we only do mortgages and nothing else; and have been 1 of the top-10 brokers in Canada for the last 5 years.
Please feel free to call or reply with comments or questions.
These are exciting times,
Mark Herman, AMP, B. Comm., CAM, MBA-Finance
1 of the Top-10 brokers of 1,700 at Mortgage Alliance
Direct: 403-681-4376
Accredited Mortgage Professional | Mortgage Alliance – Mortgages are Marvelous
Toll Free Secure E-Fax: 1-866-823-1279
E-mail: mark.herman@shaw.ca | Web: http://markherman.ca/
A study conducted by Maritz Canada showed customers renewing or renegotiating with a mortgage broker’s help reported a rate decrease of 1.40%, compared to a decrease of 1.00% among all mortgage renewals.
Brokers are your best choice for seeking home financing advice and assistance.
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?
Banks Have Canceled their 4-year Promos – Rates on the rise.
Still time to get a rate hold at the old rates if you hop to it.
The banks 2.99% four-year fixed promotions were intended to last until February 29. RBC and others have cancelled them early.
The nation’s banks rates are now:
- 4-year fixed “special offer” by 40 bps to 3.39% – ours is at 2.99% – live deals only, closing in 30 days or less
- 5-year fixed “special offer” by 10 bps to 4.04% – ours is at 3.09% / 3.25% – live deals only, close in 30 days or less
- 5-year fixed posted rate by 10 bps to 5.24% – ours is at 3.29%, 120 day rate hold
Some quick points on these changes:
- Other major banks are expected to match some or all of RBC’s rate increases.
- For just 10-20 bps more (i.e., 3.09-3.19%) you can find several brokers offering 5-year fixed mortgages. That’s a reasonable premium for one extra year of rate protection.
- RBC’s 4.04% five-year “special offer” is almost a full point above 5-year fixed rates on the street. No one other than the most novice mortgage shoppers take this rate seriously.
- RBC spokesman Matt Gierasimczuk attributed today’s rate increases to this:
“Our long-term funding costs have gone up considerably due to global economic concerns and, while we have held off in passing on these rate changes to our clients, it is now necessary for us to increase this mortgage rate.” (Source: Bloomberg)
- We can find nothing to suggest RBC’s 4-year fixed funding cost rose 40 basis points since mid-January. It has among the lowest cost of capital in Canada and other lenders have recently launched new 2.99% four-year specials of their own (one of them today). That is some pretty bad spin they are trying to put on.
- The Globe and Mail quotes sources who say that regulators were unhappy with the “price war” that followed BMO’s 2.99% five-year special. That may be somewhat linked to this announcement, hints the article. The government is clearly worried that low rates may incite borrowing and inflate the debt balloon further.
Rates, spreads and all the rest
This is an article that was sent to me. It is totally technical and I love it. This is the real reason behind what are the lowest rates we have ever seen.
It also explains why the days of Prime -.95% are GONE for what looks like a long time.
In between the lines is says rates are going to go up quickly as soon as there is a sniff of recovery.
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In the last few days, RBC and Scotiabank have eliminated their advertised variable-rate discounts.
They’re now promoting variable mortgages at prime + 0.10%, twenty basis points more than their previous “special offers.”
Prime + 0.10% (i.e., 3.10%) is an interesting number. A few months ago consumers thought that fat variable-rate discounts were here to stay. Variables above prime will now come as a shock to some people.
The banks are well aware of that. They know that pricing above prime impacts consumer psychology.
They could have priced at prime. Spreads are not that horrendous. But pricing above prime makes more of an impact. It makes higher-profit fixed rates more appealing and it mentally prepares consumers for potentially higher VRM premiums down the road.
That said, banks are not just arbitrarily sticking it to borrowers. Far and away, the main reason variable rates are worsening is that banks’ costs are rising.
At the moment, there are multiple factors at play:
• Higher risk premiums are compressing margins.
O We have Europe to thank for the that.
O The TED spread, a measure of interbank credit risk, just made a new 2½ year high. As volatility increases, banks have to factor that into their funding models.
O Another reflection of risk is the most recent floating rate Canada Mortgage Bond (which some lenders use to fund variable-rate mortgages). It was issued at a 15 basis point premium over the prior issue in August.
• Margin balancing is an underlying bank motive.
O Banks have publicly stated their desire to even out margins between profitable fixed rates and low-margin variables, and they’re slowly doing just that.
O Back in September, RBC Bank exec David McKay put it this way: “…Given the dislocation between fixed and variable, the very, very thin margins (of variables), we felt we needed to move prices up in our variable rate book.”
• New regulations (e.g., IFRS) have boosted the amount of capital required for mortgage lending.
O That has lowered the return on capital for mortgages, and thus influenced rates higher.
• Status Quo for prime rate doesn’t help margins.
O Lenders partly rely on deposits (that money rotting in your chequing and savings accounts) to fund VRMs.
O Demand deposit rates rise slower than prime rate. So, when prime goes up, some lenders get wider margins temporarily.
O When expectations changed three months ago to suggest that prime rate will fall or stay flat (instead of rise like expected), it was bad news for some deposit-taking lenders. That’s because they now have no spread improvement to look forward to in the near-to-medium term.
O MBABC President Geoff Parkin says that until recently, “lenders have been prepared to accept low (VRM) profit margins with the knowledge that, as the prime rate inevitably rises, so too will their profit on variable mortgages.” As it turns out, the inevitable is taking longer than the market expected.
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How do we (mortgage brokers) know rates are going up?
Hi All – many people ask how we know that rates are going to change ahead of time. Below is a sample of the data that we read on a daily basis. If you were motivated enough to read things like this every day – or figure them out for yourself – then you would know too. Or, just let a mortgage broker do it.
MARKET COMMENTS
Bond yields today are roughly where they were a week ago but there has been plenty of volatility over the intervening period.
Last week yields were pushed higher by in-line or better than expected economic data in Canada (Manufacturing Sales Growth, Trade Balance) and the US (Retail Sales Growth, Initial and Continuing Jobless Claims, Trade Balance), together with a sense of optimism that the European debt crisis will be resolved and/or that concerted steps there would be taken to protect the banking system.
Generally speaking, “good” economic news tends to push bond yields higher as market participants are less interested in the safety bonds provide.
Notwithstanding last week’s developments, yields have come back down today as worse than expected economic data in the US and a clarification from Germany that a once-and-for-all solution to Europe’s debt crisis will not be forthcoming and that markets should expect such crisis to extend into next year.
In all, these developments present the global economy in better shape than what we thought at the start of the week, and the rise in rates reflects that change.
A 180 Degree Change in Mortgage Rate Expectations
This last blip in the stock market has taken the wind out of the world’s recovery sails. It now looks like rates are going to stay the same or go DOWN!?! for the 12 months or so.
The USA has said for the 1st time ever that they are not going to change their rates until 2013. They have never given a date in the past and this IS a big deal. It means that Canadian rates are going to have to track closely to the USA rates or our dollar will skyrocket and quickly slow our growth and path to recovery.
That would mean that while fixed rates have NEVER been better in 111-years, variable rates are also super attractive because Prime (P) will now stay close to 3% (where it is today) and the rate of P-8% = 2.2% for a mortgage is CRAZY low now that we know it is going to stay around there for 2 more years!
Call to discuss if you have any questions on this. 403-681-4376: Mark
A 180 Degree Change in Rate Views
- 46% probability of a rate cut Sept. 7.
- 100% probability of a rate cut by year-end.
That’s what prices of closely-followed overnight index swaps (OIS) were implying at the close of business on Monday. OIS trade on market expectations for Bank of Canada rate moves.
That amounts to a 180 degree swing in market psychology. Just a few weeks ago traders were pricing in a rate hike by January.
“As we’ve seen, markets can swing and perception can swing quite aggressively, and we could well be back to a fall expectation [of a rate hike] in a month’s time,” said RBC economist Eric Lascelles to the Globe & Mail.
Lascelles counterpart at Scotiabank, Derek Holt, says: “Any talk of the Bank of Canada hiking this year is just foolish in my opinion.”
Peter Gibson, chief portfolio strategist at CIBC World Markets notes: “I think it’s clear that there are a lot of serious problems still in the world and it’s more likely that we’re setting the stage for a sustainably low level of interest rates for a very long time.”
And that is the takeaway here.
Despite the roller coaster of emotions as of late, this about-face in rate assumptions reminds us of the necessity to focus on long-term trends. Long-term, North America’s prognosis still seems compatible with low-growth and low-inflation. That’s an environment where fixed mortgage rates typically underperform.
Analysis: Canada rates seen lower for longer; cuts unlikely
This is good news for people in variable rates AND fixed rates.
It all means that mortgage rates are going to stay low for longer than expected. Prime will stay lower longer partly because the US has for the 1st time said that they will leave the very low rates until 2013 to give the market something solid to work from.
That will also cause the fixed rates to stay lower, longer.
Good news all around.
By Ka Yan Ng
TORONTO (Reuters) – A dovish U.S. Federal Reserve will likely force the Bank of Canada to keep its interest rates lower for longer, but market bets on a Canadian rate cut by year-end are unlikely to pay off.
Analysts said a rate cut would send all the wrong signals for an economy that is growing, albeit slowly, and could hurt the central bank’s credibility.
“In the current situation, a rate cut by the Bank of Canada would mean that you have a second recession in Canada,” said , Charles St-Arnaud, Canadian economist and currency strategist at Nomura Securities International in New York.
“And that’s not something that we see happening.”
Expectations for Canadian interest rates have swung wildly in recent weeks. As recently as July 19 traders priced in higher expectations of a rate increase this year, following unexpectedly hawkish language from the Bank of Canada.
A July 20 survey of primary dealers showed most saw a rate hike in September or October.
But tightening expectations fell sharply as the U.S. debt ceiling debate and the downgrading of the U.S. credit rating by Standard & Poor’s fueled fears of a recession there, triggering some of the worst stock market selloffs since the collapse of Lehman Brothers in 2008.
Canadian overnight index swaps, which trade based on expectations for the Bank of Canada’s key policy rate, and short-dated government debt began to show expectations of a rate cut rather than an increase.
The Canadian dollar also fell more than a nickel against the greenback as the outlook for monetary policy moved from tightening to easing.
Rate cut expectations were reinforced by the U.S. Federal Reserve’s unprecedented announcement on Tuesday that it would likely keep rates near zero for another two years.
Analysts said the Bank of Canada is likely to keep interest rates lower for longer than previously expected because of the Fed move. One issue is that widening the rate differential between the two countries could cause an unwelcome appreciation in the Canadian dollar.
But they caution that swap markets, which are pricing in a quarter-point rate cut before year end, have it wrong.
Analysts said a cut is not needed because the Canadian economy, though highly dependent on the big U.S. market, is still growing. The central bank’s key policy rate, currently at 1.0 percent, is also seen as still being very accommodative. The rate was cut to a record low of 0.25 percent after the financial crisis.
HOUSING, RISK TO CONFIDENCE FACTORS
Those emergency rates provided conditions for the domestic housing market to surge to bubble-like proportions in some parts of the country, and allowed Canadians to take on massive personal debt loads.
Analysts said a rate cut could reignite these two segments of the economy, risks that have already been flagged by the central bank.
“The bank is going to need a lot more evidence that the downside risks are going to stick with us before they totally rewrite their script from the last statement and move toward outright easing,” said Derek Holt, an economist at Scotia Capital, noting that dovish language would inevitably have to accompany a decrease in the central bank’s key rate.
“That would be a blow to business and consumer confidence in the country as opposed to the more supportive role, which would be essentially to just stay off on the sidelines and not do anything on rates for a long time yet.”
Holt is already the most bearish among Canada’s 12 primary dealers — institutions that deal directly with the central bank as it carries out monetary policy — and is comfortable with his call that the next rate hike will be in the second quarter next year.
If anything, it could be later, “if the Fed is true to its word in terms of maintaining stimulative policy all of next year and into 2013,” he said.
Analysts said the risk of a rate cut is now more likely than an increase, given Canada’s trading ties to the United States and the risk that a recession there would also pull Canada’s economy lower.
“It is probably appropriate to price in some risk of the next move by the BoC being more a cut than a hike, just at this stage,” said Michael Gregory, senior economist at BMO Capital Markets.
“But I think that fades within six months and you start to believe that is going to skew to the next risk being a hike rather than a cut.”
($1=$0.99 Canadian)
The background on the US debt and why Obama is doing a good job
There is lots of Obama bashing going on – mostly fueled by Fox News.
I am not political at all, and do not comment on it in general, but economically speaking Obama is doing all the right things: keeping up government spending to fuel the recovery and cutting taxes to reduce the debt. This is textbook economics.
the Bush tax cuts are one of the biggest problems, and as you can see, the US rich are getting what they want – keeping the tax cuts.
See below, this most excellent chart, of the size of the mess that Bush handed over to Obama and what he has to work with. A pretty poor hand to start with.
Obama’s and Bush’s effects on the deficit in one graph
From the New York Times :
What’s also important, but not evident, on this chart is that Obama’s major expenses were temporary — the stimulus is over now — while Bush’s were, effectively, recurring. The Bush tax cuts didn’t just lower revenue for 10 years. It’s clear now that they lowered it indefinitely, which means this chart is understating their true cost. Similarly, the Medicare drug benefit is costing money on perpetuity, not just for two or three years. And Boehner, Ryan and others voted for these laws and, in some cases, helped to craft and pass them.
To relate this specifically to the debt-ceiling debate, we’re not raising the debt ceiling because of the new policies passed in the past two years. We’re raising the debt ceiling because of the accumulated effect of policies passed in recent decades, many of them under Republicans. It’s convenient for whichever side isn’t in power, or wasn’t recently in power, to blame the debt ceiling on the other party. But it isn’t true.
Teetering on the edge of a rate hike – not all bad news
This article below is good news for everyone with a variable rate – as it looks like they will not go up that fast.
The data below is the most accurate with out any hype that I have seen is a while.
Teetering on the edge of a rate hike
Well we have a better idea of where Bank of Canada Governor Mark Carney stands, and it appears that we’re teetering on the edge of a rate hike.
This comes as no surprise, with many analysts crying for a rate increase for some time now. The question is whether it will be at the next meeting, or the meeting after that, or even before year end.
The key takeaway is that Carney signaled that ‘some’ government stimulus ‘will’ be withdrawn, rather than ‘all’ and ‘eventually’ withdrawn. That means he’s close to pulling the plug. We are looking at growth and employment numbers for the second half of the year and if it remains strong, we may see rates move before year end.
With this week’s announcement put on the backburner, analysts are focused on where we’re going over the next several months, and they certainly have a lot to consider in their projections.
The Bank has a goal of a neutral rate, which bolsters the economy yet controls inflationary pressures. There’s no magical ‘neutral rate’, but economists figure it’s in the 3%-4% range. However, Carney seems reluctant to pull the trigger on rates, considering the likes of the U.S. economy along with the issues we see in several European countries. If we widen the rate gap with the U.S. it will only drive the loonie up further, creating more resistance for economic growth.
Another external factor is the European sovereign debt crisis, in which Carney senses more concern over their troubles that the U.S. will default on its debt. The chances of the U.S. defaulting on its debt is slim and more of a scare tactic than anything. Don’t get me wrong, it’s a huge problem and the Obama Administration doesn’t know whether to turn left or right, but at the same time, if the US defaulted we’d be talking about a whole new worldwide fiasco.
Since the Bank of Canada doesn’t declare what a neutral rate is, it’s hard to determine when and how much rates will move when they do. By the way that Carney is talking it appears as though when rates do start to rise that they will in a controlled manner and they won’t be too aggressive. Analysts and economists shouldn’t assume that rate increases are going to be quick and steep.
Here at home our economy seems to be moving along as projected, and any sudden, high rate increases will be sure to stifle our growth. It looks like if everything goes to plan we may see a modest hike in October, but if some of the assumptions are off a bit it may be later before we see any movement.