29 Mar

The 10-year versus 5-year mortgage: Which is better?


Posted by: K.C. Scherpenberg

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Mortgage debates used to centre around whether to go fixed or variable but the discussion these days is not whether to lock in a rate but for how long?

Variable rate mortgages have slumped in popularity over the last few months as discounts off of the 3% prime rate are either shrinking or disappearing. At the same time, financial institutions have dropped rates to as low as 2.99% for terms as long as four or five years.

But there is a new entrant to the marketplace — the 10-year mortgage. The Canadian Association of Accredited Mortgage Professionals says 10-year mortgages are about 1% of the marketplace but that may change as rates for the decade-long term have dropped to an all-time low with some lenders said to be offering an interest rate of 3.84%.

The choice is ultimately a personal decision and highly dependent on your risk tolerance. While variable represents the most risk, given its floating rate nature, the 10-year represents the ultimate in security coming with the heaviest insurance premium — albeit with a much lower cost these days.

One key factor about the 10-year that people forget is that under Canadian law you can only be forced to pay three months interest, after five years, to break a mortgage. That’s a much lower penalty than the interest rate differential which can be in the tens of thousands of dollars.

Personally, I’m going to go with the five-year model. I like the 2.99% rate offered these days and even if it comes with restrictions like a 25-year amortization, you’ll end up paying your mortgage down faster.

You could face limits on prepayment terms of 10% of the mortgage per year but if you have say a $500,000 mortgage what are the odds you’ll have more than $50,000 kicking around? You only increase monthly payments by 10% but odds are that will be enough for most people.

If you do choose a 10-year mortgage, one issue to consider is how portable that mortgage is should you want to sell or move. You might also ask if it’s assumable by the buyer because if rates do go up, and you want to sell your home, a cheap mortgage could become a marketable commodity.

The Financial Post asked several people in the industry to pick between a five-year and 10-year mortgage. Here are their opinions:

Aaron Lynett/National Post files

Brian Johnston

Brian Johnston, president of home builder Monarch Corp., says he’d go for the 10-year product. He’d opt for the same length for commercial money too.

“If I could get a 10-year at 4%, I would take that all day long. I said to my wife ‘let’s just go get a mortgage’ and she said ‘we don’t need a mortgage.’ I said ‘it’s 10-year at 4%.’ Interest rates will go up, we all know that, we just don’t know when. Give me 10 years and I think I’ll get it right,” says Mr. Johnston. “It’s unheard of to lock in money for 10 years at these rates. It’s not going to last long.”

Ted Rechtshaffen, certified financial planner with TriDelta Financial, says he just had the debate with a client and, based on his math, if you think rates are going to be higher than 4.7% in five years you should lock in for the 10.

“If you can do a five-year mortgage at 3.14% or a 10-year at 3.89%, the renewal rate is going to have to be lower than 4.7% for you to be mathematically better off doing five years as opposed to 10,” says Mr. Rechtshaffen. “It’s not going to take a lot to get to 4.7% in five years, that’s a historically low rate. I would suggest the odds are good you are going to have a mortgage rate that is 5% plus. My client was also asking about investment property and, to be able to lock up the investment rate risk for 10 years, that has considerable value.”

John S. Andrew, adjunct assistant professor at Queen’s University’s School of Urban & Regional Planning & School of Business
Queen’s University, is leaning towards the 10-year.

“I’m biased towards the 10 just because I think rates are going to up considerably in that sort of time frame,” says Mr. Andrew. “The only reason I would say don’t go for 10 is in the rare circumstance where someone is going to pay down their mortgage in less than 10 years. For most people, the lifespan of the mortgage is going to be more than 10 years. We know these are historically low rates. Even though you are paying more for the 10-year than the five, it is going to prove to be a really good deal and why not lock in it for as long as possible. It’s going to look like a sweet deal by year three.”

Doug Porter, deputy chief economist with Bank of Montreal, says it’s a close call but he’s leaning towards a five-year mortgage.

“It’s a tight decision between the five and the 10. They are both exceptional offers. Purely as an economist, I have a gone through what we would have to assume for the Bank of Canada on medium term rates and it’s a close call. For someone who does have a lot of financial flexibility, that certainty is a good thing. There is an outside risk the global economy could be hit with an inflation check in the next 10 years given the huge amount of government debt outstanding and today’s rates will look laughingly low. Based on a traditional outlook, the five is slightly superior.”

Vince Gaetano, principal at Monster Mortgage and a long-time proponent of variable rate mortgage rates, is a convert to the 10-year.

“The product itself is no longer just a product, it’s a plan and a strategy to get rid of debt,” says Mr. Gaetano. “People should strongly consider taking on a 10-year product, especially individuals maturing from the 2007 market and who are coming out of 5.1% to 5.7% products. Keep your payments based on the same rate and take a 10-year and your mortgage will drop in half by the end of the term.”

Tim Fraser for National Post

Jamie Golombek

Jamie Golombek, managing director of tax and estate planning with CIBC Private Wealth Management,. says he would go five years.

“While there is potential for interest rates to rise over the five-year term of the mortgage, they would have to rise significantly for me to have been better off potentially overpaying during the first five years of a ten year term. That being said, choosing the ten year rate is essentially buying insurance and peace of mind, which is a valid option for many Canadians,” says Mr. Golombek.

Farhaneh Haque, director of mortgage advice and real estate-secured lending at Toronto-Dominion Bank sounded a little torn on choosing between the two terms.

“You have to understand whether that home is something you are going to look to live in for the long haul,” says Ms. Haque. “The rates are in your favour if you want to live somewhere for the long haul and you want to budget around your income. The 10-year could make sense. If you feel you are going to be moving and your life may be changing, you consider the five-year.”

Michael Polzler, executive vice-president, RE/MAX Ontario-Atlantic Canada, didn’t pick between the two but says long-term mortgages have taken over the market.

“While variable rate financing has been the favourite child of real estate consumers to date, longer term, locked-in mortgages can provide greater peace of mind for homebuyers who can’t afford an upward spike,” said Mr. Polzler. “Today’s five and 10-year closed terms, available at unprecedented rates, are ideal for purchasers who want the security of a fixed monthly payment. For those considering this option, the timing has never been better.”

Moshe Milvesky, professor at York University, think the ultimate question of whether to go five or 10 years needs to considered in the light of your overall finances.

“In these extraordinary economic times, I believe that history is less relevant for the purpose of forecasting or projecting future interest rates. Indeed, the volatility of short-term rates in the last few years has been close to zero. But it would be ridiculous to extrapolate that volatility is dead. If anything, the risk of a ‘pop’ in rates is ever growing,” says Mr. Milevsky. “I believe that Canadians should first and foremost take a comprehensive approach to what I like to call ‘debt allocation.’ The type of debt you take, its maturity, quantity and flexibility should be determined in conjunction with the rest of your personal balance sheet. Period.”

28 Mar

Mortgage rates have nowhere to go but up!


Posted by: K.C. Scherpenberg

Mortgage rates have nowhere to go but up

Garry Marr Mar 27, 2012 – 7:22 PM ET | Last Updated: Mar 27, 2012 7:33 PM ET

The logic is pretty simple. You hit rock bottom and there is no where else to go but up.

Mortgage rates on terms of five years and 10 years have never been this low. You can go back 50 years and not find a rate of 2.99% from one of the major banks for a fixed-rate product for five years. The 10-year, an almost unheard of length for most Canadians to commit to, has touched down at below 4%.

Even sticking it out with a variable-rate product linked to the prime lending rate still looks pretty good with most major financial institutions offering some type of discount off their 3% floating rate.

Already there are signs rates could be on the increase. The bond market — which mortgage rates are based on — has been rising fast and the big banks say their most recent specials will come to an end this week. But even with a 50 basis point increase, a five-year fixed closed mortgage of 3.5% is almost unheard of historically.

“Everybody is looking at the bottom here and thinking, ‘When are rates going to go up?’” says Kelvin Mangaroo, president of RateSupermarket.ca which produces a monthly forecast from leaders in the mortgage industry.

Even among the experts, few foresaw this price war in the mortgage sector. “With the big banks getting very aggressive again, it took a lot of people by surprise,” said Mr. Mangaroo. “I think people were thinking the status quo would hold for a while.”

He says the last Bank of Canada announcement about the economy had people thinking at some point the overnight lending rate, which impacts the prime lending rate, would go up, but not this year.

“Now that people are thinking of early 2013, that has people talking but really that is just so far out says Mr. Mangaroo. “It’s really just an abstract concept at this point.”

Craig Alexander, chief economist with Toronto-Dominion Bank, says he can understand how there might be some fatigue from consumers hearing about rising rates.

“Unfortunately, we have been saying for years ‘that’s it, rates can’t go any lower than they are today’ and then they are [lower] 12 months later,” Mr. Alexander says.

But this time out, he says, it almost seems impossible that rates on a five-year closed mortgage could go lower than the current 3%. “Short of the Canadian economy going into a recession and causing the Bank of Canada to cut rates back to their all-time low, there really isn’t an environment that would lead to significantly lower mortgage rates,” Mr. Alexander says. “The downside here is extraordinarily limited.”

20 Mar

Experts worry over household debt.


Posted by: K.C. Scherpenberg

Experts worry over household debt

by The Canadian Press – Story: 72606
Mar 18, 2012 / 8:21 am


Pressure is building on Finance Minister Jim Flaherty to intervene for a fourth time on mortgages to keep Canada’s housing market and household debt in check.

When he met with economists in early March, Flaherty heard conflicting advice about whether it was time to clamp down Canadians’ appetite for housing and new debt.

Since then, the Bank of Canada has reasserted in its interest rate statement that household debt is the “biggest domestic risk” and, late last week, TD Bank’s chief economist Craig Alexander called on the minister to wait no longer.

Alexander has suggested three options and asks the minister to choose one, including reducing the maximum amortization on mortgages to 25 years from 30 or hiking the minimum down payment to seven per cent from five.

As a third option, he suggests a means test for those seeking loans by ensuring they can afford to make payments as if mortgage interest charges rise to 5.5 per cent, about twice as high as many current rates.

“I’m not recommending we do anything that would drastically hurt the market,” said Alexander. “It’s like you are driving on ice, you don’t slam on the breaks, you just tap the brakes to diminish the risk of a problem.”

Capital Economics analyst David Madani believes it may already be too late to tighten mortgages and that house prices are due to start falling.

In the past six years, Flaherty has tapped the brakes on three separate occasions, starting when amortization was at 40 years and no down payment was required to obtain a mortgage. Each time, Canadians took notice for a while, then proceeded to again jump back into the market.

The latest figures released last week show household debt accumulation is still rising at six per cent annually, home sales climbing by 8.6 per cent and the average home price near record levels at $372,763.

Alexander believes Flaherty, who expressed concern about household debt after his March 5 meeting with economists, is resisting intervening now because he has a bigger concern.

With employment growth having stalled in the past half-year, Flaherty fears discouraging home buying would at the same time kill construction jobs.

In one sense, Flaherty is in the same box as Bank of Canada governor Mark Carney, who dares not raise interest rates because it could disrupt other parts of the economy.

The argument against not acting, however, is that if housing does not cool on its own, when the correction does come it could be drastic enough to stall the fragile recovery.

On the other hand, notes Derek Holt of Scotiabank, if Flaherty applies the brakes, he might get more slowing than desired. That could not only hurt construction, but the overall confidence of consumers, whose spending represent about 60 per cent of the economy.

“One has to be careful about what one asks for,” he explained. “We’ve already tightened mortgage policy significantly and we are operating at heavily leveraged structural peaks in Canadian consumer spending and housing markets that are bound to slow as fatigue sets in.”

Still, debt continues to rise faster than incomes, despite the slight dip in the household debt to income ratio to 150.6 in the fourth quarter of 2011, from 151.9 in the third.

Analysts, including Alexander, expect the ratio to keep climbing to 160 per cent, the level it hit before the U.S. housing implosion.

Alexander points out there is no controversy among economists about the imbalance in the economy being caused by housing. All agree prices are too high, by anywhere from 10 per cent to 25 per cent, and debt is too high.

The only disagreement is whether now is the time for Flaherty to act.

Fortunately, the minister has time to wait and see, says CIBC economist Benjamin Tal, who has written extensively on housing and debt. Given the weakness of the economy, the Bank of Canada has little choice but to keep interest rates low. That gives Flaherty the flexibility to keep monitoring what happens on the debt front.

“But if six months from now, you tell me house prices are up by another six, seven per cent and mortgage activity is back to seven, eight per cent, I would be more concerned,” he said.

Alexander would pull the trigger sooner. He says he believes the case for action is now but that would be “absolutely concrete” if this spring ushers in another strong real estate season.

The Canadian Press
6 Mar

Improved Penalty Disclosures On The Way. Taking the mistery out of banking!


Posted by: K.C. Scherpenberg

Copied from Canadian Mortgage Trends.

Improved Penalty Disclosures On The Way

mortgage-penalty-disclosure5Two years ago to the day, the Finance Department promised to “bring greater clarity to the calculation of mortgage pre-payment penalties.”

Later this year, that promise will become realized.

The government has just announced a brand new mortgage “code” that requires federal financial institutions to:

“…provide more information on how prepayment charges are calculated.

…explain the differences between mortgage products, including ways to pay off a mortgage faster without incurring penalties.”

These improved disclosures have been eagerly anticipated by consumer groups, who charge banks with:

  • Obscuring penalty descriptions with legalese and vagueness
  • Failing to provide understandable formulas for calculating prepayment charges
  • Failing to provide consumers with easy access to the inputs (e.g., posted rates at origination, comparison rates, etc.) that must be plugged into the prepayment penalty formulas.

FCAC3Indeed, the Financial Consumer Agency of Canada (FCAC) says it “has observed a significant increase in the number of complaints it has received related to mortgage prepayment penalties,” especially interest rate differential (IRD) charges.

That’s not surprising given that many mortgage “advisers” themselves don’t even understand them fully.

The FCAC has also found cases where lenders’ actual IRD charges are different from (presumably higher than) the charges disclosed to consumers.

In short, the FCAC says that some lenders’ disclosures “hinder consumers’ ability to decide on mortgage prepayment.”

mortgage-penalty-formula70Going forward, federally regulated financial institutions must disclose the following to borrowers:

  1. The method (formula) for calculating the exact prepayment charge in language that is clear, simple and not misleading
  2. Where the penalty formula is complex (e.g., uses present value), a simple way to estimate penalties
  3. A description of all inputs used in the penalty formula (including things like posted rates at originations, future value, outstanding balance, all applicable interest rates, bond yields, etc.)
  4. Information on how to obtain each of those formula inputs (or the actual values themselves)
  5. An example and/or worksheet to help consumers figure out their own prepayment penalty

November-2012-Calendar3Federally regulated lenders must be in full compliance with the above by November 5, 2012. The Financial Consumer Agency of Canada will monitor that compliance on an ongoing basis.

In addition to better penalty disclosure, lenders must also provide the following to customers annually:

  • A description of the borrower’s available prepayment privileges
  • The dollar amount of available prepayment options
  • Explanation of factors that could cause penalties to change
  • Specific information needed for the borrower to calculate his/her own penalty (e.g., the rates used to calculate the penalty, balance, etc.)
  • A list of all other fees for early repayment
  • Contact information for lender staff knowledgeable about penalty calculations.

Upon request, the lender will have to furnish a written statement with the prepayment penalty (and other amounts) to be charged, with a full description of the formula used and the timeframe for which the penalty quote is valid.

Lender will also need to provide guidance on what triggers a penalty, how to avoid penalties, and how pay down principal quicker without incurring penalties.

mortgage-penalty-calculator4And lastly (and here’s the best part in our view), lenders must post calculators on their pubic websites to help determine “reasonable” estimates of penalties. No more guestimators that spit out ballpark penalty quotes that are thousands of dollars off.

We don’t make a habit of celebrating government regulation, but this set of guidelines has been badly needed. Despite the lengthy implementation, the Finance Department and FCAC deserve a salute on this one.