Mortgage crisis? Not yet!
If you believe the headlines, more than one in 10 Canadians are at risk of losing their homes. That’s the news much of the media focused on in reporting the findings of a study published last month by the Canadian Association of Accredited Mortgage Professionals (CAAMP), written by chief economist Will Dunning.
The first paragraph of the article posted on The Globe and Mail website on Nov. 9 read: "A ‘sizeable minority’ of Canadian mortgage holders would be unable to make their payments if interest rates were to increase as little as 1 per cent." The number of people at risk was put at about 650,000 or slightly more than 11 per cent of all the mortgage holders in Canada. That’s scary stuff and conjures up images of a made-in-Canada version of the U.S. housing crisis which has seen hundreds of thousands of people forced out of their homes.
But let’s hold off on pushing the panic button. For starters, Mr. Dunning went on to add some important context to his findings by saying that most of the people who might be financially challenged by rising interest rates have fixed rate mortgages. "By the time their mortgages are due for renewal, their financial capacity will have increased and the amount of mortgage debt will be reduced. Moreover, most of these borrowers (88 per cent) have 10 per cent (or more) equity in their homes. There are about 75,000 borrowers who are susceptible to short term moves of interest rates and have limited home equity — less than 2 per cent of the 5.8 million mortgage holders in Canada."
Oh. So it’s only 2 per cent who are in any imminent danger. That’s not quite as scary, is it? And just how real is the risk that those 75,000 are about to be whipsawed by rising rates? Actually, it’s very slim.
The probability of significant rate increases any time soon is almost zero and as long as the economy remains in a weakened state it will stay that way. The Bank of Canada has already made it clear it has no plans to raise its benchmark rate in the near future, which now stands at 1 per cent. With the U.S. Federal Reserve Board on hold until mid-2013, a rate increase here is unlikely before then because of the upward pressure it would exert on the Canadian dollar. Commercial banks aren’t bound by what the BoC does but they rarely make major changes to mortgage rates without a signal from Ottawa.
So those 2 per cent of homeowners who could be placed in a bind by a rate increase have some breathing room to put their financial house in order, perhaps as much as 18 months.
I did a series of radio interviews on this subject with CBC stations across Canada after the report was released and I was frequently asked what people can do to ensure they don’t get into trouble with their mortgage. Here are some tips.
Know the impact of a rate hike. There are several on-line calculators that enable you to see in a few seconds how vulnerable you would be if interest rates rose. One that is very easy to use can be found at www.fiscalagents.com/toolbox/cal/mort/mortgcal.shtml. Simply input the house price, the down payment, interest rate, and the amortization period and hit "Calculate". You’ll immediate see the amount of the monthly payment. Then experiment with the interest rate to see what happens if it rises.
I used a $250,000 mortgage with a 25-year amortization as the base case. At an interest rate of 4 per cent, the monthly payment is $1,315. If the rate increases to 5 per cent, it adds $139 to that amount. At 6 per cent, you’d have to pay $285 more than at 4 per cent. Obviously, the greater the size of the mortgage, the more money a rate hike would cost in dollar terms.
Don’t overspend. Bidding wars are still going on in some cities, with homes selling for well over the asking price. That could lead to trouble for some buyers down the road. Our housing market has held up remarkably well but in some areas (hello Vancouver!) there appears to be a real estate bubble. Folks who overpay for a property today could find themselves begging to get out of the deal tomorrow if prices drop. That’s almost a certainty when interest rates start to rise.
Pay the lowest interest rate possible. There is an on-going debate over whether to choose a variable rate mortgage, which has the lowest rate, or lock in for six months to five years (sometimes longer) and pay a premium in the form of a higher rate. I am firmly in the variable rate camp — why give a bank more of your after-tax dollars than you have to?
However, anyone in a vulnerable position should protect themselves by setting up their payments as if they had taken a five-year term. The additional money will go to paying down the principle faster and will act as a cushion in the event rates rise unexpectedly.
Haggle. Never accept the posted mortgage rate. Financial institutions, like car salespeople, are usually prepared to bargain. Mr. Dunning’s study notes that mortgage rate discounting is widespread in this country. “During the past year, the average ‘posted’ rate for five-year fixed rate mortgages was 5.38 per cent. Discounted rates are estimated at an average of 3.92 per cent, implying an average discount of 1.46 points,” he writes.
It helps to go to the negotiation with some ammunition. Prepare yourself by visiting www.canequity.com/rates/ where you’ll find current rates for a wide range of banks, insurers, trust companies, and credit units. It will open your eyes.
For instance, as of Nov. 10, most of the major banks were showing a posted rate of 4 per cent on a variable rate mortgage. But at Scotiabank the quoted rate was only 2.9 per cent while some credit unions were in the 2.5 per cent range. Toss those numbers at your bank’s mortgage manager and more often than not he or she will make you an offer you can’t refuse.
If you would like to read the full CAAMP report, it can be found here.
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