Financial trouble : a very real possibility for Canadians renewing their mortgage...
For over twenty years, mortgage interest rates in Canada have lowered, making a "mortgage maturity date" an event looked forward to by many borrowers. That's because, at the end of their mortgage term, borrowers traded higher interest rates for lower ones and even consolidated expensive unsecured debt into their home loan. They acquired the benefits of lower monthly payments and more room for monthly savings.
Today, things have changed. Bidding wars are no longer typical. Houses for sale are flat (some with no offers). New mortgage rules make mortgage qualification extremely challenging, and interest rates are increasing.
According to Bank of Montreal, 47% of mortgages are set to renew within eight months, and according to betterdwelling.com, rate hikes would hurt approximately 63% of mortgage holders in 2018. That's because 30% of mortgages are currently variable rates. And, in light of the new drastic and consecutive rate hikes initiated by the Bank of Canada, fewer people will be comfortable taking a variable rate product.
The reality is striking.
What can borrowers do today?
When it comes to mortgage approvals, appraisals are almost always required by banks & other various lenders. Appraisals determine a property's value, so, in order to refinance and even consolidate unsecured debt, the value must be sufficient. With homes becoming more difficult to sell, and purchasers experiencing financing difficulties, the value of home prices are slowly decreasing. This translates to lower appraisal values.
One way borrowers may find it difficult to cope with rising interest rates is if they have a fair amount of unsecured debt. Credit cards and other loans can become very costly and difficult to pay down. Refinancing or debt consolidation may no longer be an available option for the many of Canadians who rely on their home's equity to bail them out of more expensive debt.
One should seriously consider refinancing soon to optimize on the following:
Feel free to call with any questions.
Wong, Daniel. "Bank of Canada: Half of Canadian Real Estate Mortgages Will Renew By Next Year." Better Dwelling. November 29, 2017. Accessed February 04, 2018. https://betterdwelling.com/bank-of-canada-half-of-canadian-real-estate-mortgages-will-renew-by-next-year/amp/.
"BMO: '47% of Canadian mortgages are due to reset within 1 year'." The Globe and Mail. November 29, 2017. Accessed February 04, 2018. https://www.theglobeandmail.com/globe-investor/inside-the-market/bmo-47-of-canadian-mortgages-are-due-to-reset-within-1-year/article37122628/.
Financial books I recommend:
Bank of Canada announced today it has increased it's short-term rate by a quarter point to 1.25. All big banks will increase their Prime Rate to 3.45% tomorrow. Royal Bank of Canada is the first to implement this change. CBC News. (2018). Big banks move to match Bank of Canada's rate hike. [online] Available at: http://www.cbc.ca/beta/news/business/bank-of-canada-rate-decision-1.4490918 [Accessed 18 Jan. 2018].
Some highlights over the last week:
What does this mean?
A variable rate product will go up .25%. So, if the rate is 2.3%, it will now be 2.55%.
Why timing is everything in a volatile market.
There are many changes occurring in the real estate market and they are all happening very fast. At the beginning of the month, a new stress test was implemented, which now has borrowers qualifying at 2% higher than the contract rate. Today, more bad news, interest rates have gone up, again. Many would argue that these changes are happening too rapidly, and they are right. Unfortunately, by the time most come to understand what is going on and how it will impact them, it will be too late for them make any changes to their financial situation.
Here's what I mean.
The new stress test will take about six months to ripple through the real estate market. As more people find it increasingly harder to qualify for financing, sellers will have to start to reduce their prices to move property. This is the outcome OSFI hoped for. Some experts predict a decline of property value by 40% or more.
The cooling of the market is great for purchasers, however, not great for the many people who rely on their home's value.
Who do these people include:
Let's talk about the first group of people.
Canadians have a large amount of unsecured debt. Student loans, car loans and other personal loans often take up a large allocation of a person's pay cheque. And, for the last ten to fifteen years, homeowners have enjoyed a real estate market of property value increases and endless possibilities. For example, people have been able to refinance and consolidate debt (often minimizing the pain of large interest payments), triple their net worth by purchasing investment properties using their home's equity, put their children through school, buy family cottages and so on. All of this with the help of low rates, increasing property value and easier mortgage qualifying criteria. Today, the curtain of this dream is slowly coming to a close.
In January, the second stress test which now makes borrowers qualify at 2% higher than the contract rate. In 2016, the first stress-test, which wiped out over 30% of first-time home buyers, mortgage programs for the self-employed and many equity programs. In the last 6 months, rapid interest rate hikes. It may be too fast for Canadians to even grasp what this means for them.
In order to refinance debt into a first mortgage, property value must be substantiated with an appraisal. An appraisal can be 30-60 days old. In a declining market, an appraisal is a crucial factor since if the property's value cannot be confirmed, problems with financing will occur. For example, lenders will only offer up to 80% of the home's value in a mortgage (if the borrowers qualify), and so, if the appraisal cannot confirm adequate value, an application to refinance will not be approved.
Why is this important? If borrowers have debt they need to consolidate, now is the time to seriously review one's finances. There is nothing worse than being trapped in monthly, interest-only payments at 19.999% interest, WITHOUT the possibility of debt consolidation.
So, homeowners who have unsecured debt need to realize the current climate and act accordingly.
Many retired people will want to liquidate their homes soon in an effort to downsize and put money in the bank. If property value decreases drastically, this diminishes their retirement fund. In this case, retired individuals can look into the CHIP/reverse mortgage program while property values can be substantiated today.
As anyone can see, a homeowner needs their home's value for many reasons, if not just for security. The market is very volatile and many consumers aren't sure where it's headed. And, since the market is obviously no longer one of decreasing interest rate and more lackadaisical mortgage terms, consumers should look and most importantly, plan ahead.
Many borrowers are not aware of the different compensation models for both mortgage brokers and banks. Further, they are usually unaware that different lenders pay brokers different amounts of commission. Why is this important?
Firstly, any consumer needs ensure that they are in fact, getting the best deal. If a broker has a few possible financial institutions they can submit an application to, then it's important they don't submit to a lender paying them the most but instead, one offering the best deal to the borrower. A borrower's life and financial goals should not be meddled with - this isn't a casino!
When it comes to interest rates, they may seem good to the borrower but are they the best? Another question that should be asked: are the terms of the mortgage the best? Is there flexibility within the mortgage contract? Are there any lenders offering something better? And if so, what are their terms?
Because most people are not aware of how mortgage brokers get paid to begin with, they are surprised to find out that there are indeed different amounts of commission being offered to brokers. There are over 20,000 mortgage brokers across Canada, so it's important that borrowers choose to work with those not motivated by "how much compensation" but rather, "is it the best deal for the borrower?"
This isn't to portray bank representatives as angels, either. Most bank specialists are also incentivized by bonuses, raises and in most cases, their employment. This means they are graded on how much volume they do or in other words, how many products they sell. Therefore, borrowers also want to ensure they are not put into a mortgage product just because the person at the bank needed to reach their monthly quota.
Increasing capital - tax free.
When you purchase an investment property, eventually, if you sell it, you will have to pay Capital Gain's tax. No one will argue the fact that paying this tax is unfair. But, instead of complaining about it, let's look at one primary way to minimize this tax.
How does Capital Gain's tax work? Let's say you invested $10,000 of your money into an investment property. Within a few years of owning that property, you decide you wanted to sell it for $50,000. Capital Gain's tax would be the difference between your original investment of $10,000 and the sale price of $50,000. Half of the resulting $40,000 would get taxed at 50% (20,000) at your current personal tax rate. In other words, only the difference of $20,000 would have to get taxed.
So, if you are retired, your overall tax would be less than if you were earning a full-time income, so this means timing also plays a part in how much tax you pay.
What's exempt from Capital Gain's tax? Your principal residence is not subject to any tax. The Tax law permits that you don't have to pay any tax on the profit you make from selling your primary home. You can do this once a year. So, in the event you spot a bargain on the market, you could improve the property while living in it. This is just one way you can significantly increase your capital, tax-free over many purchases.
Source: DAKU, D.15 secrets the taxman doesn't want you to know Daku, D. (n.d.). 15 secrets the taxman doesn't want you to know. Nassau, Bahamas: Eagle Pub.
Have a mortgage question?
By: Sarah Colucci (January 8, 2018)
Consumers are aware that mortgage brokers and financial institutions flight to save their client's money. Competition is intense on all fronts. Credit unions, major banks, monolines and, of course, in between themselves (i.e., Mortgage brokers vs. in-house bank and credit union staff). So, how does a consumer pick the best avenue for financing?
Mortgage rates are usually the main highlighted item that somehow convinces consumers that they will get the best deal. Websites such as ratespy.ca and ratehub.ca elude that interest rates are the most crucial factor in getting a mortgage. The names of these websites also display their objective. Interest rates are essential; however, prepayment penalties and the flexibility of the mortgage are just as significant. In my opinion, it's unfortunate that consumers are not publicly alerted about the consequences of only thinking about the rate.
Take pre-payment penalties, for example. The prepayment penalty business is a multi-billion dollar industry. If a customer is initially set up to fail because they signed a lousy mortgage contract, the interest rate they received won't matter. For example, in the all-too-common situation of a purchaser locking into a five-year fixed rate. Here's how. Firstly, if they got a mortgage with a financial institution that uses higher-than-usual posted-rates (ex. using the Bank of Canada's benchmark rates to calculate their penalties). If that purchaser needs to exit their mortgage within the term because of life circumstances, they will pay the most amount of money to do so. On the flipside, if they got the same mortgage with a lender that didn't use the Bank of Canada's benchmark rates but, instead, used lower rates in their calculations, their penalty would be smaller. This difference could easily equate to over $10,000 in savings for that purchaser. BUT, in reality, financial institutions, who are in the business to make money, keep their revenue streams flowing from the ignorance of the ordinary borrower (and from working with the wrong professionals, too). Also, professionals who may not be able to show their clients the benefits of thinking outside of just the rate may lose the war against "rate shoppers."
When it comes to flexibility.
The devil is definitely in the details when it comes to mortgage contracts. Most borrowers want to pay less money for their mortgage - that is their primary objective. So, they erroneously believe that getting the best rate equals lower monthly payments which then equals being mortgage free sooner. Unfortunately, this is not always the case, and a simple assumption like this could have serious financial consequences.
When certain lenders offer their "lowest rates," the terms are usually punitive. This means that real money-saving privileges like doubling up on or increasing monthly payments are not allowed. When a borrower can increase their mortgage payment or double up on their payments, more principal, and less interest are paid. Missing an opportunity to do this has the reverse effect of what they initially set out to do - be mortgage free sooner.
Extra fees/mortgage broker and bank compensation model
There is some confusion amidst the general public about how mortgage brokers get paid. It's a no-brainer that both the bank and the broker channel compete for business but how do each get paid and how can that affect the money the consumer will save or spend?
Firstly, mortgage brokers can get paid two ways. 1. They can charge a broker fee. 2. They get paid by the financial institution that approves the borrower's application.
When a financial institution approves an application for a residential mortgage, the broker is paid by them. This payment is called an origination fee. What this means is the lender will pay the broker a commission for referring an application to them. The borrower will not pay any fees. Sometimes, depending on the work that was involved in getting the file approved, a broker may choose to charge a broker fee, which would be paid by the borrower. In this case, it would depend on who the purchaser decided to work with as NOT ALL brokers charge a broker fee on top of the compensation they are already receiving.
In some cases, there will be no compensation to the mortgage broker from the financial institution. Usually, this happens when arranging commercial and private loans. If a purchaser is organizing this type of financing through a mortgage broker, they should expect to pay a brokerage fee.
The main benefits of working with a mortgage broker are that their success depends on the following:
1. getting a borrower approved
2. finding them the best deal by consulting a wide range of lenders, including but not limited to major banks and credit unions.
3. generating repeat business and a referral source.
Compensation model for major banks
Mortgage Specialists employed by major banks are usually not accredited and don't have any specific certification with governing bodies (for example, mortgage agents and brokers are licensed by FSCO). They typically get incentivized by the bank they work for based on the volume they do. For example, their raises and bonuses and in some cases, even employment, depend on them arranging to finance property and/or offering other credit products. There are no fees ever charged to the borrowers concerning lender/broker fees.
Some of the downsides of working for major banks include:
1. limited resources to consult when applying for approval. Meaning, the banks don't have access to the funds of many other lenders currently available.
2. Not licensed (less information available to the consumer).
Benefits would include no fees getting charged to the client, waived appraisal fees (which are usually paid for by brokers as well).
Overall, the main lessons borrowers should learn are:
1. Mortgage contracts have "fine print" which should be read carefully by borrowers to ensure they are getting the best deal.
2. Borrowers shouldn't rely on what a mortgage broker or bank specialist tells them. They should do their due diligence - ask questions, read the contracts.
3. The interest rate, although significant, is not the most critical part of a mortgage contract.
4. Calculate prepayment penalties with multiple lenders to see the cheapest option before you sign on the dotted line.
By: Sarah Colucci
Senior Mortgage Agent, Lic. M14000929