27 Feb

Monday Morning Interest Rate Update (February 27, 2012)


Posted by: K.C. Scherpenberg

Monday Morning Interest Rate Update (February 27, 2012)

Copied from: David Larock in Mortgages and Finance, Home Buying

If you want to look beyond the incendiary headlines about housing bubbles in Canada’s largest real estate markets, last week’s report by the Bank of Canada (BoC), called Household Finances and Financial Stability Review, is worth a read. The report highlights several areas of concern, but it does not suggest any imminent collapse in house prices.  

Here is a summary of the key points I took away from the report (with my comments added in italics):

  • Our debt-to-disposable income ratio has been rising steadily for thirty years, but this run-up has occurred in two distinct phases. Up until the mid-1990s, the increase in mortgage debt was largely caused by higher house prices, but since then, borrowers have increasingly been using the equity in their homes to finance consumption. A classic case of living “beyond our means”.
  • The instrument that facilitated this shift from borrow-to-buy-your house to borrow-to-fund-your-lifestyle was the secured home equity line of credit (HELOC). In 1995, HELOCs accounted for 11% of non-mortgage credit, and by the end of 2011 that number had grown to almost 50%. The higher house prices have risen, the more aggressively HELOCs have been marketed and the more common home-equity extraction has become. (Further proof that Finance Minister Flaherty’s decision to halt CMHC’s back-end insuring of HELOCs last year was prescient.)
  • Debt levels are higher for every age-group cohort. Not even our aging population (which should have a moderating effect on overall debt growth because older people borrow less) has done much to offset the substantial rise in our debt levels.    
  • While lower interest rates have reduced the cost of borrowing for everyone, the report notes that “an easing of affordability would have a greater impact on the housing decisions of younger age groups”. (Example: Between the ages of thirty-one to thirty-five, a person born between 1964 and 1968 had an average debt of $75,000, while a person born between 1975 and 1979 had an average debt of almost $120,000.)
  • This helps explain why we have seen a substantial increase in the home-ownership rate, which rose from 63.6% in 1996 to 68.4% in 2006 (and has increased further since then).

There is inherently more risk when low interest rates induce young borrowers to enter the housing market earlier than they otherwise would. The length of their borrowing life cycle means that young borrowers are far more likely to face higher interest rates with a still substantial debt load in the future. When BoC Governor Carney and Finance Minister Flaherty repeatedly remind Canadians that “interest rates will go up”, they are looking straight at today’s young buyers. 

Those are some risks worth worrying about. But before we all start storing canned soup and building bunkers in the hinterland, the report also offers some encouraging points to keep in mind:

  • While measures of house price affordability have been decreasing of late, the BoC’s report shows that affordability levels today are still below their thirty-year average: “Despite increases in house prices, generally favourable labour market conditions (gains in real income) and low interest rates have supported affordability and contributed to significant increases in home ownership and mortgage debt.

Interesting point from a Bank of Montreal report last week: While average house prices have risen more quickly than nominal GDP (a proxy for average income levels) over the last ten years, the reverse was true in the prior ten years (when nominal GDP rose faster than house prices). I was surprised to see that when you look back over twenty years, nominal GDP and house prices have both grown by an average of 4.7%.   

  • The BoC’s report makes clear that the U.S. housing bubble  was primarily caused by two factors:

1) A relaxation of mortgage underwriting standards. (At its peak, U.S. sub-prime borrowing accounted for 14% of outstanding mortgage borrowing versus 3% in Canada.)

2) Easier access to borrowing that was secured against home equity.

While I think we should be concerned about the effect that increased borrowing against home equity is having on our overall debt levels, the most widely reported statistic about Canadian debt-to-disposable income ratios being higher than they were in the U.S. at the peak of its housing bubble is actually quite misleading. A recent BMO report laid this comparison bare when it showed that Canadians can contribute much more of their disposable income to debt servicing because they do not have to cover substantial costs, such as healthcare, from their after-tax earnings (as Americans do). When BMO used a more apt comparison, debt-to-gross income, it showed that our debt levels are nowhere close to where U.S. levels peaked. Furthermore, even today, U.S. debt-to-gross income levels are substantially higher.

  • The BoC’s report concludes that “the trend rise in Canadian house prices is associated with a growing population and income, which has increased demand, coupled with an upward-sloping long-run supply curve owing to the increasing scarcity of land for residential development, primarily in urban areas.”

In other words, the BoC still thinks our house price appreciation is supported by sound fundamentals.

13 Feb

Collateral versus Standard Charge Mortgages.


Posted by: K.C. Scherpenberg

Collateral versus Standard Charge Mortgages

Another lender has moved to collateral charge mortgages so it’s becoming increasingly important to understand the differences between a collateral and standard charge mortgage.  Which is better for you?  It all depends on your preferences and future needs.  
Collateral charge is ideal if you want to be able to access your equity for debt consolidation, renovations, or to invest in property or investments easily and cost effectively. Your mortgage is registered for the same or more than the property value; 100% at ING, 125% with TD Bank, which is why you can access your equity. The downside is at renewal because your negotiating ability with your lender may be affected; it is harder to switch lenders without getting a new mortgage and paying legal fees. In addition, the lender may be able to seize equity to cover other debts with that same lender.
Offered by the majority of lenders, standard charge is ideal if you won’t need to refinance your mortgage during your term, and if you want to have the ability to easily and cost effectively move from lender to lender at renewal. If you have a standard charge and need to borrow more, you have the option of a second mortgage or line of credit. Some lenders offer both – standard charge mortgages and HELOCs, which are often a collateral charge.
Whether you’re buying your first or next home, getting ready for renewal, taking out some equity for debt consolidation, renovations, or investing, let us help you get the right mortgage type (collateral or standard charge) with the rate and features matched to your needs.