October 30, 2006
Some sweeping changes are coming to the mortgage industry in Canada.
For decades, a person's ability to afford a mortgage was determined by two numbers (ratios). Total home ownership costs compared to total family income and total debt compared to total family income.
Basically your home ownership costs could not be greater than 32% of your salary and your total debt could not be greater that 40% of your total salary.
For example, someone making $50,000 could afford a mortgage size of $175,000 (more or less) given a 5% down payment.
This is about to change.
Competition breads better products and this is what is happening in the mortgage industry. For years CMHC has been the sole supplier of mortgage insurance. Even if your mortgage wasn't insured, CMHC had a major role in determining your bank's mortgage policies.
A few years ago GE (General Electric) was given permission to compete against CMHC. They did a great job and some improvements in the mortgage business, as CMHC and GE wrestled for market share, are apparent. (i.e. lower insurance fees)
The story is about to start a new chapter. AIG has come to Canada and will become the third competitor to enter the mortgage insurance business.
CMHC wasn't a great competitor being, at heart, a government run organization. However, GE (renamed Genworth) and AIG are going to clash in ways that will be great for the general consumer.
The first bout will lay waste to the decades' old fixed ratio numbers mentioned above.
Starting Monday October 23, 2006 that same person making $50,000 can now afford a mortgage size of $290,000 (more or less) given a 5% down payment. That is over a $100,000 difference. The best part is that the mortgage interest rate charged on either mortgage will be 5.25% or whatever the current best rate is.
The new rules allow for a 44% of total debt to total salary and allow for 40 year amortizations. The 32% ratio has been dropped altogether.
Please note you need to have very good credit and very little other debt in order maximize you mortgage size.
If you have mortgage questions we have answers.
Dan Eisner AMP, MBA
True North Mortgage
October 20, 2006
Ever wondered how are mortgages rates set? Well, read on ...
Does the Bank of Canada set all interest rates?
No. The Bank of Canada sets the "target for the overnight rate." The overnight rate is the interest rate that banks charge each other to cover their short-term daily transactions. The target for the overnight rate is a half-percentage-point band.
The chartered banks use the overnight rate as a guide in setting their prime lending rate - the rate at which the bank's best customers can borrow money. When the central bank changes its overnight rate, it's sending a signal to the chartered banks that it wants them to change their prime lending rates.
The Bank of Canada does not directly set mortgage rates or credit card rates. Variable mortgage rates and other floating rate loans like lines of credit move up and down in lock step with the prime lending rate. But the rates for fixed mortgages depend more on the bond market. Banks rely on the bond market to raise money for those kinds of mortgages. Interest rates on the bond market can move up or down more frequently than the prime rate because the bond market is far more sensitive to market fluctuations. Rates move when traders believe the central bank may be about to increase - or reduce - interest rates.
What happens when rates go up?
It goes without saying that it costs more to borrow money when interest rates increase. This doesn't have much of an impact on most day-to-day buying decisions. But if you're in the market for a house, you might think twice about buying as rates rise. For instance, if you need a $200,000 mortgage - which is not uncommon now that you can buy a home with essentially no down payment - you would be paying $1,163.21 every month in principal and interest for 25 years, if your mortgage interest rate was five per cent.
But if that rate was just one percentage point higher, your payments would be $1,279.62 per month. And that doesn't include property taxes. Bump the rate to seven per cent and your payments are just over $1,400 a month. Might be enough to make you think twice about buying.
And if you don't buy, then those big box hardware stores might not see as much of you since you won't be renovating that new house. Same goes for the furniture stores that wanted to sell you that entertainment unit for the new home theatre you were thinking of installing.
On the other hand, if you've paid off your mortgage and have a whack of cash lying around, higher rates mean the bank will pay you more to let your money sit with them in savings accounts or GICs which, reduces your propensity to spend.
The central bank moves to higher rates when it believes the economy is in danger of growing too rapidly. Rapid economic growth could cause a cycle of rising prices and wages. The central bank wants that growth to be moderate, so inflationary pressures are kept in check.
What happens when rates go down?
The simple answer is, of course, that the cost of borrowing goes down. But there's method behind the maneuvering. Lower rates are an unmistakable signal from the central bank that it's worried that the economy is weakening and people aren't buying enough big-ticket items. Lowering rates helps to spur economic growth because it makes it more attractive for businesses and consumers to borrow. The central bank must be careful not to inject too much stimulus into the economy or it risks igniting inflation. Correctly forecasting this balance of risks is the central bank's most difficult and most important task.
When are interest rates set in Canada?
The Bank of Canada sets rates eight times a year - in late January, early March, mid-April, late May, mid July, early September, mid-October and early December.
The Bank retains the option of taking action between fixed dates, but only under extraordinary circumstances.
The U.S. Federal Reserve also sets rates eight times a year. The Bank of England sets rates 12 times a year.
Where are rates going?
Depends who you ask. The bond market as of late is showing rates going higher. That is why, we believe, banks won't be lowering their mortgage rates any further. In our opinion, rates will move sideways for the next 30 days or so.
Sincerely,--The Team at True North Mortgage