Mortgage Shoppers!   Weekly Market Insight by Benjamin Tal (June 11, 2010):

In Canada there are clear signs that the housing market is softening.  Housing starts are slowing, while supply of existing houses is outpacing demand.  This raises the issue of the quality of mortgage credit in Canada, and how significant will higher rates will be impacting the market as a whole.

Note that the vast majority of home owners in Canada regardless of their age have not experienced any worsening in affordability despite the rapid increase in prices.  The only sub-group of households that have seen some deterioration in their affordability position is older Canadians with average income of less than $50,000.  Zooming in on this group we find that on average they spend close to 60% of their gross income on mortgage payments, property taxes and electricity costs.  This is three times the average ratio seen among households at the same age groups but with income of over $50,000.

The practical implication of this finding is that the composition of the mortgage market in Canada has, in fact, improved over the past few years.  Interestingly, there is no significant difference in affordability between households with fixed rate mortgages and those with variable rate mortgages.  While variable mortgage holders enjoy lower interest rates, the average mortgage they carry is 7% larger.

While one cannot ignore the risk of an outright decline in home prices in the coming 12-18 months, nothing in the data supports a market crash.

As opposed to the US, the share of mortgage holders in Canada has in fact declined in recent years, while the increase in the average size of mortgage has not coincided with a significant worsening in affordability.  While higher interest rates will clearly erode affordability, our detailed look at the distribution of mortgage payments as a share of income does not reveal major pockets of vulnerability.

Accordingly, the most likely scenario is that higher interest rates will lead to a modest decline in prices (probably in the magnitude of 5%-10%) in the coming year or two.  But given relatively modest rate hikes and the current balanced affordability position, the more significant adjustment will be in housing market fundamentals that are likely to catch up with prices in the coming years—paving the way for a healthier housing market by mid decade.

Well, the fix is in, when it comes to the Canadian mortgage market.

New government rules have taken away choice from many Canadians and will force them to lock into a long-term mortgage.

You’ll hear a chorus from commentators who will say this is a good thing because Canadians can be assured of their mortgage payments over the next five years — especially important as the Bank of Canada looks set to raise its key lending rate in June or July.  An increase in prime will immediately follow and that will raise the cost of borrowing for anybody with a variable rate product.  What nobody is talking about is how the discount on variable rate products has shrunk considerably.

Prime is 2.25% but some light negotiation will easily get you 50 basis points off taking your variable down to 1.75% today.  Credit markets have calmed and the cost of capital on short-term money has shrunk to the point where discounts are heading down.  At the height of the credit crisis, consumers were paying 100 basis points above prime for a variable rate product.  At the best of times before the crisis, variable rates had been almost 90 points below prime.

Canadians know that variable rate products do better almost 90% of the time, even though they do come with increased risk.  They also know that in the last two weeks the five-year fixed rate mortgage has risen 85 points, meaning even discounters can only get you something in the 4.6%-range if you decide to lock in for five years.

The problem is the new government rules are taking away the variable option for some consumers — up to 10% of the market, according to some people in the mortgage industry.  Ottawa’s new rules mean even those with variable mortgages have to qualify based on their ability to pay the posted five-year fixed rate, now 6.1%, and soon will be 6.25%.

The only way you can use the rate on your contract for qualifying is to lock into a term for five years or longer.

In a cruel irony, the policy and the drive by the banks to get everybody into five years might be responsible for driving up rates, according to Mr. Tal.  Because of all the money going into long-term mortgages, banks are selling more long-term bonds.  The flood of paper is creating increased supply and driving down bond prices – that means an increase in yields.  The banks then have to raise their mortgages rates to match what is going on in the bond market.  There is no question that many consumers are happy to go with a fixed-rate mortgage and pay tens of thousands of dollars of extra interest for the security of having their rate stay fixed for five years.

But what about the people who still want to choose?  Some of them will be out of luck.  If short-term rates rise quickly, the government protected them.   If they don’t, the federal government will have cost them a bundle.  A fixed-rate mortgage may cost you more, but may also help you sleep better at night.

Mortgage Rule Changes effective April 19, 2010.

Here are the highlights of some new rules to high-ratio mortgages in Canada:

The Minister of Finance recently announced changes to high-ratio government guaranteed mortgages. In response all federally regulated lenders will be making the following changes to their high-ratio (greater than 80% LTV) lending policies effective Monday, April 19, 2010:

-       Refinances: Maximum LTV (Loan to Value) is reduced from 95% to 90%.

-       Non-owner occupied Rentals: Max LTV is reduced from 90% to 80% (essentially no longer available under high ratio)

-       Second Homes: Maximum number of units reduced from 2 units to 1 unit.

-       Qualification Rate: For HELOC, ARM/VRM, 50/50, and fixed terms less than 5 years, borrowers will be qualified using the greater of the 5 year benchmark rate* or the contract rate.  *The benchmark rate 2s available on the following website: http://www.bankofcanada.ca/en/rates/interest-look.html.

The benchmark rate is not only applicable to high ratio deals. Deals with LTV of 80% or less may continue to follow the lenders’ (in some cases) the pre-April 19 qualifying criteria.  That is another reason you should use my services.  There is no way for you to find out.

In addition, for some lenders, the following typical policy changes will be applicable to all LTV ratios (more clarification will appear in future blogs):

-          Rental Income (Subject Property): The TDS (Total Debt Servicing) formula will reduce the gross rental income utilized from 80% of gross rental income from all rental properties to 50% of gross rental income from the subject property to be included in the borrower’s gross annual income for calculating TDS.   Please note this mean your traditional mortgage helper will not be included for GDS (Gross Debt Servicing) calculation.  Your will find explanation on both GDS and TDS at my Web site.

-          Rental Income (Other Properties): Rental income from other properties will be treated the same as other non-salaried income using the average income for the previous two years Notice of Assessment line 150 plus 15% gross up.  Audited financial statements or engagement financial statements prepared by a licensed accountant may be considered if the 15% gross up is not sufficient.  In other words, if someone has investment rental properties and has not declared their rental income for income tax purposes, lenders will not include those incomes for qualifying.

The video below is by “The Mortgage Teacher” – Michael Mullis, a mortgage agent in Ontario.  He has something very useful to say. I enjoy it; so I am sharing it with you: