New rules for borderline borrowers

Posted on 01. Dec, 2010 by in News

Garry Marr, Financial Post · Tuesday, Nov. 30, 2010

Two minor mortgage rate hikes in the past two weeks are nothing to panic about but they do illustrate how eight-month-old government regulations could affect some Canadians.

Go back to the middle of November and consumers could get a five-year closed mortgage for as low as 3.39% with the more common discounted rate 3.59%, says Gary Siegle, the Calgary-based regional manager for mortgage broker Invis Inc. Now the common discounted rate for a five-year closed mortgage rate is 3.79%.

“It was only two 10-basis-point increases,” Mr. Siegle says. “These rate hikes have been [triggered] by international unanticipated events. They could be adjusted back down because there may be not repercussions in our economies to justify those [increase] rates. There is no hurry in North America to increase rates.”

In the interim, though, the latest hikes forced the government of Canada to increase its posted five-year rate from 5.29% to 5.44%. The rate is based on what banks charge and is only important because of changes Ottawa made to mortgage regulations in April.

Anybody with less than a 20% down payment and borrowing from financial institutions covered by the Bank Act must have mortgage insurance. Qualification for mortgages is now calculated on your ability to make payments based on the posted rate. The exception is if you agree to a term of five years or more, you can use the actual rate on your contract.

The impact is pretty clear for borderline borrowers. They can forget about a variable-rate mortgage tied to prime, which is now as low as 2.3%, because they have to qualify based on 5.44%. Lock in and they get to qualify based on the current 3.79%.

Some consumers are probably thanking the government for forcing them into long-term contracts, which hit a record low last month for a five-year deal.

“If you have any income-test challenges or are marginal, you have to go for a five year,” Mr. Siegle says. “If you look at 2.3% vs. 3.79%, that’s only 140 basis points. At one point the gap was 200 basis points.”

Benjamin Tal, a senior economist with CIBC World Markets, says the expectation is the Bank of Canada will not raise its overnight lending rate, which prime tracks, until the middle of next year. Still, he said it’s unlikely the gap between variable rates and five-year mortgages will widen.

“If you take variable today versus fixed, the difference will be insignificant,” says Mr. Tal, basing his calculations on what the variable rate and five-year mortgage rate will be over the next half-decade. “It’s really almost a wash.”

And that’s after two consecutive long-term mortgage rate hikes. “There is some risk rates will go up in the next few months, reflecting the fact the bond was extremely expensive and yields were much too low,” he adds.

Mr. Tal says another 50 basis points in long-term rate increases would probably tip the scales back in favour of the variable.

John Turner, director of mortgages with Bank of Montreal, says the latest hikes are not significant. “If you look at a rate of 3.4% versus 3.5% on $100,000, that’s a difference between $501 a month and $494 a month on a 25-year amortization,” he says.Mr. Turner says the increase to the posted rate will also not have much of an effect, in terms of qualifying consumers for loans. “It’s a very insignificant number,” Mr. Turner says of the percentage of consumers that would have to lock in the rate for five years because they can’t qualify based on the posted rate.

“If they are that tight, they have to ask themselves whether they should be buying a home that expensive,” Mr. Turner says.

It’s a fair comment, and there are probably a few consumers who are happy they were forced to lock in their rate at what turned out to be a record low. But how happy will consumers be in the coming months if the gap between prime and long-term rates widens and government regulations prevent them from getting a variable-rate mortgage?

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