Are rates going up or down?

In the past couple of days, several lenders have announced mortgage rate increases including CIBC, Firstline, President’s Choice Financial and TD. Other’s may soon follow suit. Why are rates going up you ask? Weren’t they supposed to be going down?

Earlier this month, the Bank of Canada reduced the overnight rate by a quarter of a percentage point. The overnight rate immediately impacts the prime rate, which impacts the rate you pay on a variable rate mortgage. This move was largely precautionary. The very high dollar we were experiencing in the Fall was taking it's toll on our manufacturing and export, and inflation had eased off -- so it made sense to reduce the overnight rate.

Since August, when the U.S. subprime crisis first hit, Canadian banks have been acknowledging that they have some exposure to ACBP's (asset backed commercial paper) -- ACBP's are investments that represents baskets of consumer loans which include U.S. subprime loans. The Canadian government froze trading of ACBP's to avoid panic selling but the problem has not gone away, and it has quietly been putting upward pressure on lending rates. To compensate for losses, banks increase lending rates.

So what does this mean to you? If you are in the market for a property, get a preapproval/rate hold in place good for 120-days to protect you against possible further increases. Even if you would like to go with a variable rate mortgage, the spreads on variable rates could change too, so it's wise to get something locked in as soon as possible. If your mortgage rate is coming up for renewal soon, ask your lender for an early renewal.

How I learned to recycle

I was the king of garbage. I am not proud of it, but it's true. And when throwing out garbage was in fashion, I was the best at it. Every one or two weeks, I would grab a big green garbage bag and digging deep into our fridge, I pulled out leftover food. Then I went around from room to room, filling up the bag. You name it, it went into the garbage.

And then something changed and suddenly I realized that it become practically impossible to throw out your garbage anymore. City workers drove by my house once a week with a big truck that looked a lot like a garbage truck, but they weren't taking the garbage. The garbage started piling up in my garage and I knew that something had to change.

When I started complaining out loud about how ridiculous it was that you couldn't throw out your garbage anymore, my step-daughter broke down into tears one day and started telling me all about Al Gore and global warming. "If you don't change your ways" she said, "soon we will all be under water". Whether I agreed or not, one thing was for sure -- if I didn't change my ways, we were all going to be under garbage.

Eventually I reformed and now I am now the garbage nazi in my house. Nobody is permitted to throw food in the trash -- it goes straight into the green bin. And today as I carried this very heavy green bin down to the curb, it occurred to me how much food had gone to waste in the past week, and I realized that we probably could have fed double the number of people in our house with the amount of food wasted -- time for another family meeting.

Is it Ethical for Lenders to Offer Stated Income Mortgages?

In the U.S. some people refer to them as 'liar loans'. They are called 'stated income' mortgages and not everyone knows this, but they are also available, and very popular in Canada. With a stated income mortgage, the applicant is not required to provide proof of the income amount stated on the application. Mortgage lenders consider a number of factors when determining the amount of money they are willing to loan -- one of the factors is the amount of income an applicant earns. Even mainstream lenders such as banks offer these types of loans, where proof of income is not required. Why do such loans exist?

It is understood that people can't always prove the amount of income they earn. For example, self-employed people normally try and minimize the amount of income they report for tax purposes. The amount of income reported by a self-employed person may be reasonable from a tax point of view, but lenders know that the net income may not be a good measure of the person's true earnings.

What are the consequences of lending on a mortgage application where you don't know how much the person actually earns? Potentially, they are very serious. From time to time I meet with people who just want to know the maximum mortgage amount they will qualify for. It is very important for any borrower to carefully consider the size of payment they can afford to carry.

Ultimately, it is the borrower’s responsibility to determine what payment they can afford. It is the lender or mortgage broker's responsibility to make the borrower aware of the types of mortgage products available to them, costs and risks.

With a fixed-rate mortgage the rate and payment are fixed for the term of the mortgage – the most popular terms are between one to five years, though you can get a term as long as twenty-five years. At the end of the term, the renewal rate will be based on then current rates. It usually costs more to get a longer term fixed rate mortgage, but you get peace of mind knowing that your payments will remain fixed for the entire term. Variable rate mortgages are tempting because the rate is usually lower than the current fixed rate; however, if the prime rate goes up, the payment may also go up. If you are considering a variable rate mortgage, you need to know that you will be able to make the payment in the event that the rate goes up.

If the borrower is made aware of their mortgage options and they understand the costs and risks associated with the mortgage they are getting, then in my opinion, it doesn't matter what income amount is stated on the application.

Shop around for the best mortgage deal at renewal time

It's important to shop around before your mortgage renews, to make sure you're getting the best deal. It's free to transfer your mortgage to another institution, but you'll have to do paperwork all over again, credit checks and provide income verification to the new lender. Unless your very unhappy with your present lender/bank, it's usually easier and makes sense to renew with your current lender, as long as they match or better the best available rate.

Eliminate virtually all market risk with a 15-year fixed rate mortgage

In the past couple of weeks, given the fallout in the U.S. mortgage and real estate markets, a couple of prospective home buyers who were considering purchasing a property this fall, have asked me whether they should hold off on their plan to buy a property. Should they "wait and see", they asked. My short answer is no -- in my opinion, it's still a good time to buy real estate in Canada.

First of all, the mortgage and real estate picture in Canada is very different than in the U.S. Subprime lending is the major cause of the fallout in the U.S, and as a percentage of all mortgages, subprime lending is considerably smaller in Canada than it is in the U.S. -- less than 5% of all mortgages in Canada are subprime vs. 20% in the U.S. Further, many of the mortgages under repayment in the U.S. are so called "teaser rate" mortgages which offer an extremely low payment for the first couple of years. After the teaser period is over, with interest rates in the U.S. up, many borrowers have found that they are unable to pay their mortgages. While they originally thought they would be able to refinance on an expectation of higher property values, they now find themselves unable to do so because instead of house prices appreciating, they have depreciated.

In Canada, most borrowers take 5-year fixed rate mortgages so we do not have the the same exposure to changes in lending rates as our neighbours to the south. Further, the real estate market in Canada continues to perform very well, and when you consider that the average 5-year fixed rate mortgage in Canada over the last 30-years was 10%, mortgage rates are still relatively low. You can get a 5-year fixed rate mortgage at rates as low as 5.74%. With mortgage rates as low as they are and with all the new mortgage products including extended amortizations, zero down mortgages and no income qualifier mortgages for self employed, many people who previously could not afford to buy a home can now do so.

For most people, the greatest single variable impacting real estate affordability is the mortgage rate. While it is unlikely that what has happened in the U.S. will happen here in Canada for a number of reasons -- our economy is strong, employment is strong and immigration continues to drive demand for real estate -- if you are worried that the problems in the U.S. could spill into our economy and impact our mortgage and real estate market, you could virtually emliminate all risk simply by taking a longer term mortgage. Take a 10 or 15 year fixed rate term at around 6%, and you could practically coast through one complete economic cycle. On the other hand, if you decide to put off buying and if interest rates do go up in the medium term (in the near term there is no expectation of higher rates), you could turn around in a few years to find that you have effectively been priced out of the market.

Attractive mortgage solutions still available for borrowers who don't qualify at their bank

Now that Canadian sub-prime lenders have increased rates, if you don't qualify for a mortgage at your bank, does that mean that you are in serious trouble? In a word, no. There are many institutional lenders that offer mortgages at about the same rates as banks, and many have more flexible lending guidelines than banks.

When it comes to insured mortgages (a mortgage needs to be insured if your down payment is less than 20%), did you know that the banks do not support all of the programs offered by CMHC and Genworth (the mainstream insurers)? Banks can be extremely picky about the types of applications they choose to loan on. Whether your mortgage application is for an insured or uninsured mortgage, mortgage brokers are often able to place mortgages at bank rates, where borrowers were previously declined at their banks. Here are a few examples of mortgage we recently placed...

• Self employed applicant unable to prove income with 5% down. Applicant's bank told him he needed a minimum of 25% down. We got an approval through an alternate lender at 5.79% rate.
• Bruised credit -- an applicant fell behind on his bills while he was out of work. After becoming re-employed he went to his bank and asked for an increase to his mortgage to consolidate his debt -- he was declined by his bank. We got him a new 1st mortgage with an alternate lender at 5.84% rate.
• Self employed, refinance with plenty of equity in house, was declined at his bank due to high debt load. We got an approval at an alternate lender at 5.84% rate.

To put the above into perspective, the rates offered by TD and Scotiabank at the time these mortgage approvals were obtained were 5.89% and 5.84% respectively.

When a bank declines your mortgage application, it can be very discouraging. Be sure you talk to a mortgage broker to have a clear picture of the options available to you.

Canadian real estate and mortgage market unlikely to follow U.S. example

Last week several Canadian subprime lenders announced rate increases and a general tightening of lending guidelines, making if harder and more expensive for subprime borrowers to get loans. This was the result of an increase in lender's cost of funds due to problems in asset backed commercial paper market -- a direct impact of the collapse of the subprime mortgage market in the U.S.

At this time there is no signal that would indicate that our real estate market in Canada will follow the same path as the real estate market in the U.S. The Canadian economy is performing well, the job market is stable, the interest rate environment is generally stable and real estate prices continue to rise unlike real estate prices in the U.S. which are declining. Also, mortgage lending in Canada is far more conservative than lending has been in the U.S. Firstly, there are far fewer subprime mortgages in Canada as a percentage of all mortgages. In Canada, subprime loans account for about 5% of all mortgages vs 20% in the U.S. Further, most borrowers in Canada (approximately 2/3), take out 5-year fixed rate mortgages -- the figure is the reverse in the U.S. With a fixed a rate mortgage the borrower can count on the fact that his mortgage payment will not change for 5-years. With a variable rate mortgage, an increase in the Prime rate can impact the borrowers ability to make payments at any time. Add to that the prevalence of 'teaser' mortgages in the U.S. that gives borrowers a low rate introductory offer that they could enjoy for 2-years after which time they would have no way of making their mortgage payments and it should come as no surprise that their mortgage industry has collapsed.

Save your credit: Avoid missing payments at all costs

I frequently get calls from people who for various reasons have found themselves unable to meet their payment obligations. Whether they are having trouble making their mortgage payments, paying credit card or telephone bills, my advice is ~ avoid missing payments at all costs!

So how do you make the payments if you are short of cash? Take out a loan, borrow from a friend or family member. If you miss payments you will damage your credit. Then later, when you try and borrow it will harder to do so and more costly because your credit will be damaged.

If you have equity in your home, use it! Get a new 1st mortgage or a 2nd mortgage while your credit is good. If your cash flow problem is temporary, you will pay down the debt later when your situation is improved. If your cash flow problem is not temporary, then you need to take steps to reduce expenses i.e. downsize.

Canadian subprime lenders increase rates and tighten lending guidelines

Last week was uneventful in the 'A' mortgage market -- no significant changes to rates.

The story in the 'B' (subprime) mortgage market however, was quite different - we saw rate increases and a general tightening of lending guidelines, making it harder for subprime borrowers to get mortgages.

What are the differences between the A and B mortgage markets?

The A mortgage market is for people who can qualify for a discounted mortgage rate. Typcially, these borrowers:

- have good credit
- are salaried, or
- are tenured self employed

The B mortgage market is made up of borrowers who don't qualify for a discounted mortgage rates. They usually:

- have some credit problem,
- if salaried they don't meet the normal income requirements, or
- are not tenured self employed

Why is the A market stable while the B market is seeing changes?

The A market is stable because lending money to strong borrowers for the purpose of buying real estate in Canada is still considered a good risk. Real estate in Canada has proven a good investment and homebuyers are unlikely to give up on paying for their homes, especially if if they are personally occupying the home.

In contrast, Canadian investors are showing some hesitation to invest in B/subprime mortgages in Canada. The source of funds that feeds the subprime market is asset backed commercial paper (ABCP) and in the last couple of weeks investors have been pulling their money out of ACBP's. This has already translated into higher borrowing costs for Canadian subprime borrowers and more stringent lending guidelines.