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TIME TO LOCK IN A VARIABLE RATE MORTGAGE?

Approximately 32 per cent of Canadians are in a variable rate mortgage, which with rates effectively declining steadily for the better part of the last ten years has worked well.

Recent increases triggers questions and concerns, and these questions and concerns are best expressed verbally with a direct call to your independent mortgage expert – not directly with the lender. There are nuances you may not think to consider before you lock in, and that almost certainly will not be primary topics for your lender.

Over the last several years there have been headlines warning us of impending doom with both house price implosion, and interest rate explosion, very little of which has come to fruition other than in a very few localized spots and for short periods of time thus far.

Before accepting what a lender may offer as a lock in rate, especially if you are considering freeing up cash for such things as renovations, travel or putting towards your children’s education, it is best to have your mortgage agent review all your options.

And even if you simply wanted to lock in the existing balance, again the conversation is crucial to have with the right person, as one of the key topics should be prepayment penalties.

In many fixed rate mortgage, the penalty can be quite substantial even when you aren’t very far into your mortgage term. People often assume the penalty for breaking a mortgage amounts to three months’ interest payments, which in the case of 90% of variable rate mortgages is correct. However, in a fixed rate mortgage, the penalty is the greater of three months’ interest or the interest rate differential (IRD).

The ‘IRD’ calculation is a byzantine formula. One designed by people working specifically in the best interests of shareholders, not the best interests of the client (you). The difference in penalties from a variable to a fixed rate product can be as much as a 900 per cent increase.

The massive penalties are designed for banks to recuperate any losses incurred by clients (you) breaking and renegotiating the mortgage at a lower rate. And so locking into a fixed rate product without careful planning can mean significant downside.

Keep in mind that penalties vary from lender to lender and there are different penalties for different types of mortgages. In addition, things like opting for a “cash back” mortgage can influence penalties even more to the negative, with a claw-back of that cash received way back when.

Another consideration is that certain lenders, and thus certain clients, have ‘fixed payment’ variable rate mortgages. Which means that the payment may at this point be artificially low, and locking into a fixed rate may trigger a more significant increase in the payment than expected.

There is no generally ‘correct’ answer to the question of locking in, the type of variable rate mortgage you hold and the potential changes coming up in your life are all important considerations. There is only a ‘specific-to-you’ answer, and even then – it is a decision made with the best information at hand at the time that it is made. Having a detailed conversation with the right people is crucial.

It should also be said that a poll of 33 economists just before the recent Bank of Canada rate increase had 27 advising against another increase. This would suggest that things may have moved too fast too soon as it is, and we may see another period of zero movement. The last time the Bank of Canada pushed the rate to the current level it sat at this level for nearly five full years.

Life is variable, perhaps your mortgage should be too.

As always, if you have questions about locking in your variable mortgage, or breaking your mortgage to secure a lower rate, or any general mortgage questions, contact us at 613-612-2111 or 613-203-2030.

 

NEW MORTGAGE CHANGES DECODED

 

This week, OSFI (Office of the Superintendent of Financial Institutions) announced that effective January 1, 2018 the new Residential Mortgage Underwriting Practices and Procedures (Guidelines B-20) will be applied to all Federally Regulated Lenders. Note that this currently does not apply to Provincially Regulated Lenders (Credit Unions) but it is possible they will abide by and follow these guidelines when they are placed in to effect on January 1, 2018.

The changes to the guidelines are focused on
• the minimum qualifying rate for uninsured mortgages
• expectations around loan-to-value (LTV) frameworks and limits
• restrictions to transactions designed to work around those LTV limits.

What the above means in layman’s terms is the following:

OSFI STRESS TESTING WILL APPLY TO ALL CONVENTIONAL MORTGAGES

The new guidelines will require that all conventional mortgages (those with a down payment higher than 20%) will have to undergo stress testing. Stress testing means that the borrower would have to qualify at the greater of the five-year benchmark rate published by the Bank of Canada (currently at 4.89%) or the contractual mortgage rate +2% (5 year fixed at 3.19% +2%=5.19% qualifying rate).

These changes effectively mean that an uninsured mortgage is now qualified with stricter guidelines than an insured mortgage with less than 20% down payment. The implications of this can be felt by both those purchasing a home and by those who are refinancing their mortgage. Let’s look at what the effect will be for both scenarios:

PURCHASING A NEW HOME
When purchasing a new home with these new guidelines, borrowing power is also restricted. Using the scenario of a dual income family making a combined annual income of $85,000 the borrowing amount would be:

Current Lending Guidelines

Qualifying at a rate of 3.34% with a 25-year amortization and the combined income of $85,000 annually, the couple would be able to purchase a home at $560,000

New lending Guidelines

Qualifying at a rate of 5.34% (contract mortgage rate +2%) with a 25-year amortization and the combined annual income of $85,000 you would be able to purchase a home of $455,000.

OUTCOME: This gives a reduced borrowing amount of $105,000…Again a much lower amount and lessens the borrowing power significantly.

REFINANCING A MORTGAGE

A dual-income family with a combined annual income of $85,000.00. The current value of their home is $700,000. They have a remaining mortgage balance of $415,000 and lenders will refinance to a maximum of 80% LTV.
The maximum amount available is: $560,000 minus the existing mortgage gives you $145, 0000 available in the equity of the home, provided you qualify to borrow it.

Current Lending Requirements
Qualifying at a rate of 3.34 with a 25-year amortization, and a combined annual income of $85,000 you are able to borrow $560,000. If you reduce your existing mortgage of $415,000 this means you could qualify to access the full $145,000 available in the equity of your home.

New Lending Requirements
Qualifying at a rate of 5.34% (contract mortgage rate +2%) with a 25-year amortization, combined with the annual income of $85,000 and you would be able to borrow $455,000. If you reduce your existing mortgage of $415,000 this means that of the $145,000 available in the equity of your home you would only qualify to access $40,000 of it.

OUTCOME: That gives us a reduced borrowing power of $105,000. A significant decrease and one that greatly effects the refinancing of a mortgage.

CHANGES AND RESTRICTIONS TO LOAN TO VALUE FRAMEWORKS (NO MORTGAGE BUNDLING)

Mortgage Bundling is when primary mortgage providers team up with an alternative lender to provide a second loan. Doing this allowed for borrowers to circumvent LTV (loan to value) limits.
Under the new guidelines bundled mortgages will no longer be allowed with federally regulated financial institutions. Bundled mortgages will still be an option, but they will be restricted to brokers finding private lenders to bundle behind the first mortgage with the alternate lender. With the broker now finding the private lender will come increased rates and lender fees.
As an example, we will compare the following:
A dual income family that makes a combined annual income of $85,000 wants to purchase a new home for $560,000. The lender is requiring a LTV of 80% (20% down payment of $112,000.00). The borrowers (our dual income family) only have 10% down payment of $56,000.. This means they will require alternate lending of 10% ($56,000) to meet the LTV of 20%.

Current Lending Guidelines
The alternate lender provides a second mortgage of $56,000 at approximately 4-6% and a lender fee of up to 1.25%.

New Lending Guidelines
A private lender must be used for the second mortgage of $56,000. This lender is going to charge fees up to 12% plus a lenders fee of up to 6%

OUTCOME: The interest rates and lender fees are significantly higher under the new guidelines, making it more expensive for this dual income family.

These changes are significant and they will have different implications for different people. Whether you are refinancing, purchasing or currently have a bundled mortgage, these changes could potentially impact you. We advise that if you do have any questions, concerns or want to know more that you contact us at info@ottawashometeam.com or call us direct 613-612-2111 or 613-203-2030. We can advise on the best course of action for your unique situation and can help guide you through this next round of mortgage changes.

   

FINAL GUIDELINE B-20 ANNOUNCED

Today, the Office of the Superintendent of Financial Institutions Canada (OSFI) published the final version of its Guideline B-20. The revised Guideline, which takes effect January 1, 2018, applies to all federally regulated financial institutions.

We were pleased that OSFI agreed with our recommendation not to create a prohibition on all co-lending activities and instead clarified that the restrictions only apply to arrangements that are designed to circumvent existing laws or policies.

We are however disappointed with the decision to implement a new stress test at a 200 basis points level. We expect this will encourage more people to take shorter term mortgages, putting more borrowers at risk should interest rates rise dramatically. We believe the new qualifying rate will have negative implications for the Canadian mortgage finance market and the national economy as a whole. Following this announcement, will continue our discussions with the Ministry of Finance and the Bank of Canada about the methodology used to set the 5 year bench mark.

OSFI will be holding information seminars later this fall to discuss implementation expectations. 

Overview of Changes effective January 1, 2018

A new minimum qualifying rate (stress test) for uninsured mortgages will be set


The minimum qualifying rate for uninsured mortgages will be the greater of the five-year benchmark rate published by the BoC or the contractual mortgage rate +2%.

Lenders will be required to enhance their LTV measurement and limits to ensure risk responsiveness

Federally regulated financial institutions must establish and adhere to appropriate LTV ratio limits that are reflective of risk and updated as housing markets and the economic environment evolve.

Restrictions will be placed on certain lending arrangements that are designed, or appear designed to circumvent LTV limits

A federally regulated financial institution is prohibited from arranging with another lender: a mortgage, or a combination of a mortgage and other lending products, in any form that circumvents the institution’s maximum LTV ratio or other limits in its residential mortgage underwriting policy, or any requirements established by law.

As always we will continue to keep you updated on the latest developments as they are announced.
   

THE IMPACT OF MORTGAGE RULE CHANGES

The mortgage rule changes that were passed by the Ministry of Finance in October 2016 are still having their effect one year later. Higher qualification requirements and new bank capital requirements have split the industry into two segments – those who qualify for mortgage insurance and those who don’t.

Mortgages that qualify for mortgage insurance are basically new purchases for borrows that have less than 20% down and can debt-service at the Bank of Canada Benchmark rate (currently 4.89%). Those who don’t are basically everyone else – people with more than 20% down payment but need to qualify at the lower contract rate, and people who have built up more than 20% equity in their homes and are hoping to refinance to tap into that equity.

The biggest difference we are seeing is two levels of rate offerings. Those that qualify for a mortgage insurance by one of the three insurers in Canada (CMHC, Genworth and Canada Guaranty) are being offered the best rates on the market. Those who don’t qualify cost the banks more to offer mortgages due to the new capital requirements and so are offered a higher rate to off-set that cost.
Dominion Lending Centres’ President, Gary Mauris, wrote a letter to the Prime Minister and the Minister of Finance at the beginning of October 2017 outlining the negative impact of those changes on Canadians on year later. That letter was also published in the Globe and Mail. CLICK HERE to see that letter.

But even more alarming are the rumblings being heard about another round of qualification changes that will see those who have been disciplined in saving or building equity having to qualify at a rate 2.00% higher than what they will actually get from their lender.
Where the first round of changes in 2016 saw affordability cut by about 20% for insured mortgages, this new round of changes will have much the same impact on the rest of mortgage borrowers – regardless of how responsible we’ve proven to be.

The mortgage default rate in Canada is less than 1/3 of a percent. We Canadians simply make our mortgage payments. So where’s the risk?
The new qualification rules are intended to protect us from higher rates when our current terms come to an end. But when most Canadians are already being prudent, borrowing at well below their maximum debt-to-income levels the question now is why do we need to be protected from ourselves?

The latest round of rule changes are rumoured to be coming into effect by the end of October 2017 so our word of advice to at least those who have been contemplating a refinance to meet current goals? Contact us to find out your options before your window of opportunity is closed.

   

WHAT IS AN INTEREST RATE DIFFERENTIAL (IRD)? HOW DO YOU CALCULATE IT?

A mortgage in its simplest form is a contract. It has terms, conditions, rights and obligations for you and the lender. When you sign on the dotted line, you are agreeing to those terms for the length of time laid out in the contract. However, sometimes life throws us an unexpected event that brings around the need to make key decisions and changes. One of these changes, for whichever reason, might be needing/wanting to break your mortgage contract before the end of the term. Can you do that? What are the penalties? Let’s take a look!

To answer the initial question of can it be done, the answer is yes. Most mortgage lenders will allow this provided they receive compensation. Compensation is known as an Interest Rate Differential or IRD. When you started your fixed rate mortgage you had a rate of xx.x%, but the best they can lend to someone else right now is 1% less, so they want the difference. Seems fair, right? However, like most contracts, the fine print tells the true tale. The method in which the IRD is calculated is what borrowers should be aware of.

Let’s examine a few different calculations that can be used for IRD.

Method “A” -Posted Rate Method – Generally used by major banks and some credit unions

This method uses the Bank Of Canada 5 year posted rate to arrive at the formula to calculate the penalty. It also considers any discounts you received. These are the ones you will commonly see on their websites or when you first walk into the Bank or Credit Union. Now, rarely does anyone settle on that rate-there is a discount normally that is given. This gives you the actual lending or contract rate. When this method is used, you will be required to pay the greater of 3 months interest or the IRD. What that looks like is:

Bank of Canada Posted Rate for a five-year term: 4.89%
You were given a discount of: 2%
Giving you a rate of 2.89% on a five-year fixed term mortgage.

Now you want to exit your contract at the 2-year point, leaving 3 years left. The posted rate for a 3-year term sits at 3.44%. The bank will subtract your discount from the posted 3-year term rate, giving you 1.45%. From there your IRD is calculated like so:

2.89%-1.45% =1.44% IRD difference x3 years=4.32% of your mortgage balance.

On a mortgage of $300,000 that gives you a penalty of $12,960.

For most, that is a significant amount that you will be paying! It can equate to thousands and thousands of dollars, depending on the mortgage balance remaining. So what other methods are used? Let’s take a look at the second one.

Method “B”-Published Rate Method – Generally used by monoline (broker) lenders and most credit unions

This method is more favourable as it uses the lender published rates. Generally, these rates are much more in tune with what you will see on lender websites and appear to be much more reasonable. Again, let’s look at an example.

Your rate: 2.90%
Published rate: 2.60%

Time left on contract: 3 years

Equation for this: 2.90%-2.60%=0.30% x3 years=0.90% of your mortgage balance. A much more favourable outcome. On a $300,000 mortgage that would equate to only $2,700.

The above two scenarios operate under the idea that the borrower has good credit, documented income, and a normal residential type property. It is also a fixed rate mortgage, not a variable one. For variable rates, if the contract needs to be broken, generally the penalty will be a charge of 3 months interest, no IRD applies.

So, if you do find yourself in a position where you need to end your contract early get in touch with a Dominion Lending Centres mortgage broker to review your options. To avoid any surprises all together though, it is advised to consult with a mortgage professional right from the start. We are committed to ensuring that you make an educated decision when selecting a lender. Yes, we want to get you the best rate, but we also want to make sure you are taken care of.

 

   

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