“You are seeing a significant minority who value [mortgage prepayment] features and are taking advantage of it,” said Jim Murphy, CAAMP president. The CAAMP survey also found that in cases where people were renewing their mortgages at a lower rate, 24 per cent voluntarily increased their payments. Are these the people that have seen their pay rise somewhat, and have learned how to juggle the cost of running a house along with other expenses?

How often do mortgage holders make extra payments so their mortgages will be paid off ahead of schedule? Here are some answers from a survey done for the Canadian Association of Accredited Mortgage Professionals. The stats suggest more people in recent years have been trying to pay off their mortgages early.

Source: CAAMP Annual State of the Residential Mortgage Market survey, November 2011

 
What’s your vision for 2012/2013? Will you be among the growing number of homeowners making extra payments? Leave us a comment!

“Improved Penalty Disclosures On The Way
Two years ago [almost] 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 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.

Indeed, 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.”

Going 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

Federally 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.

[The] 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.

And 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.”

So how do you become your own mortgage lender? Easy! You hold your mortgage inside your RRSP and pay yourself the interest, not the bank. Sounds simple enough, right? That was easy part. Here are a few of the details:

Your RRSP becomes “the bank/lender”. Rather than paying principal and interest to the bank, you would pay principal and interest to your RRSP.  By the way,

• there must already be sufficient funds in your RRSP to cover your mortgage
• there are costs involved in setting this up strategy
• you must charge yourself prevailing interest rates
• payments don’t count as tax deductible contributions
• calculating your rate of return can be complicated

While there are advantages to this strategy, there are also disadvantages. Contact me to learn more. If 2012 is your year to renew or refinance your mortgage, talk to an Accredited Mortgage Broker (like me) first!

Have you or someone you know adopted this mortgage strategy? Leave a comment and share your views.

Sage advice would be to do what helps you sleep at night.If you choose a fixed rate, you will not have any fluctuations in your payment for the term of your mortgage. If you choose a variable rate,there will be increases in your payments at some point in time. So, if peace of mind is part of the equation, you will win even if you are paying a little more in the long run.

Canadian Mortgage Trends recently published the following article (October 17, 2011) related to fixed or variable-rate options.

“Just weeks ago you could find variable-rate mortgages at prime – 0.80% (P-.80%) or better. Consumers thought they were here to stay, but the tables turned…fast.

Economic troubles and lender profit motives have shrunken variable discounts beyond expectations. Banks are now commonly quoting prime rate, for example, with little discounting.

Once the last few holdout lenders with P-.50% [prime minus.50%] disappear, discounted variables could move towards P-.25% [prime minus .25%] or worse. Some lenders even suggest that prime or prime plus could be the new normal.

Meanwhile, aggressive brokers are selling five-year fixed rates at 3.25% or less. That’s an unusually low 50 basis point premium to a variable. A spread that tight doesn’t come around often, and it makes you rethink all of the research suggesting variables are the way to go.

Popular research indicates that people have saved money on variable-rate mortgages:

• 88.6% of the time:
  • Source: Floating Your Way to Prosperity, 2001, Moshe Milevsky, PhD; Study period: 1950-2000
• 90.1% of the time:
  • Source: Moving Mortgages, 2008, Moshe Milevsky, PhD; Study period: 1950-2008
• 83% of the time:
  • Source: Variable Rate Roller Coaster Still Hard to Beat, 2011, Douglas Porter and Benjamin Reitzes, BMO; Study period: 1975-2011

Odds like that make some people question the sanity of going fixed. But there’s a little more to the story.

While variables have cost less than 5-year fixed mortgages a majority of the time in the past, favourites don’t win every game. More importantly, assumptions are key when it comes to rate studies. Two important factors have impacted the research quoted above:

1. A multi-decade bias towards falling rates
2. Use of posted rates (instead of discount rates)

“Interest rates have been trending downward for two decades,” BMO Capital Markets Senior Economist Benjamin Reitzes told us [Mortgage Trends] in a recent interview. By default, he says, that’s tilted the table more in favour of variables than it otherwise would be.

Looking ahead, rates are no longer able to drop over one percent. The most we can realistically hope for is an extended period of horizontal rate movement. (The Bank of Canada can still cut rates slightly, but the European and American crises and sub-2% core inflation won’t delay hikes forever.)

As a result, Reitzes says, “Going forward, borrowers won’t see the same advantage to variable rates as they have in the past 25 years”

The second factor that’s largely ignored when citing rate research is the actual mortgage rates used for backtesting. Each of the three studies above uses posted rates in their historical analysis.

Reitzes states that this practice distorts the results somewhat. “Discounts off posted rates were not as prevalent historically.” Nowadays, however, “Most people get a (rate) discount if they are credit-worthy borrowers.”

That matters, because the rate discount you get obviously impacts the likelihood of your mortgage outperforming other options.

Here’s an example.

• If you look at data from 1970 to 1995, the average difference (spread) between 5-year fixed and variable rates was 126 basis points.*
• The average difference today is roughly 50 basis points.

That’s a remarkable 76 basis points lower than historical rate spreads. That makes a huge difference in research conclusions.

If you theoretically backtested with the same spreads as today (i.e., 25 bps off prime for variables and 204 bps off posted for 5-year fixeds), you’d find that fixed rates outperform considerably more often.

According to Milevsky, “…The historical probability of doing better with the floating rate mortgage…hovered around 70% to 80%” when the borrower used deep discount rates (based on a 1965-2000 study period).

Using today’s discounts, that 70-80% drops to just 53%, based on our findings from 1970 to 2006. (Obviously today’s spreads would not have applied historically but, as Milevsky maintained in his research above, that is beside the point.)

In other words, the fixed/variable decision would have been a coinflip, based on today’s spreads.

This isn’t meant to imply that fixed rates now have an insurmountable edge. If the Bank of Canada drops rates unexpectedly, a variable could easily beat all other terms over the next five years.

A variable may also prevail for other reasons. See:

• The Fixed/Variable Mortgage Conundrum
• IDEAS for Choosing Fixed or Variable

That said, if the BoC’s next rate move is up (which is the highest probability outcome, say economists), the boring old 5-year fixed could certainly outperform. That’s true even when compared to a variable with payments set at the 5-year fixed rate.

The nice part is this: If you go fixed and variables end up winning, you’ll likely be out far less money than in most prior years.”

What do you think? Please post a comment and/or question any time!

Well, the Bank of Canada conducted an extensive study on mortgage discounting and Canadian Mortgage Trends summarized their conclusions below.

The Canadians who get the best mortgage rates are those who:

Bargain

• Banks don’t offer their best rates up front.  They give better deals to skilled negotiators and well-informed borrowers.

Have larger mortgages

• “…..since few negotiate the renewal of their mortgage … (this) provides lenders with an incentive to attract consumers with larger loans who have large outstanding balances at the time of renewal.”

Use a Broker

• Report states that mortgage brokers lower the “search costs”of getting multiple quotes that translate into lower rates
• “Over the full sample the average impact of a mortgage broker is to reduce rates by 17.5 basis points.”  That’s $1,670 of interest savings on a typical $200,000 mortgage over a 5 year period.
• Bank “mortgage specialists offer convenience to consumers, although they do not reduce search costs.  This is because they work for one lender only.”

Do significant non-mortgage business with a lender

• “Branch managers have an incentive to offer large discounts to consumers ..  that are, or will be, more profitable to the bank”

Have more equity

• Those who put the minimum down payment of 5% “pay higher rates than other borrowers – about 12 basis points more” than those with a loan to value below 85%

Are new clients

• ” …new clients receive larger discounts than existing clients, on the order of 10 basis points.”

Use smaller lenders

• “We conclude that the larger a bank’s market share, the higher are the rates that it can charge to borrowers”
• “….Borrowers who are new clients at one of the Big 8 banks receive less of a discounts than borrowers who are new clients elsewhere.”

Are financially capable

• ” …..  poorer borrowers may face greater levels of price discrimination when bargaining in person at the branch than they do when transacting through a broker.”

Have better credit

• “Financial institutions …  offer better rates to high credit score consumers.”

For a complete copy of the report click Discounting in Mortgage Markets

Mortgage Brokers have a fiduciary responsibility and are bound by a code of ethics to work for you – not the banks.  So there!

A credit score is a tool used by credit grantors to determine your ability to repay your debts.  The information on your credit report is compared and evaluated against other consumer credit reports which gives you a credit score ranging from 350 (highest credit risk) up to 800 (lowest credit risk).  A higher score means you are less likely to make late payments or default on the credit extended to you. Check out the guidelines used in determining your score

What does that mean for the potential home buyer? Several factors may make it tougher for some people to qualify for a mortgage. Lenders have tightened their guidelines in recent months and will continue to do so.  Appraisals will be lower and evaluation of properties will become much more conservative.

If you are looking to refinance in the near future, it may be a good idea to get pre-approval before there is a correction in the real estate market.

Here’s some e examples of where it can matter:

• A borrower who wants a line of credit – If you have 20 – 25% equity in your property, then you will want to get approval as soon as possible. A small drop in the value of your home could change your ‘loan to value’ above the 80% minimum requirement. ‘Loan to value’ is the amount of your outstanding mortgage divided by the property’s appraised value.
• A borrower who wants to refinance for a 90% loan to value maximum – The new lending guidelines dictate a maximum loan to value of 90% for refinancing.  As an example, if your loan to value is 83%, just a small drop in housing prices will reduce your equity.
• A borrower who wants to refinance up to an 80% loan to value maximum – 80% loan to value is the maximum amount to qualify for a conventional loan i.e. no high ratio insurance. If your loan to value is 75% or more, even a small drop in housing prices could put your loan to value over 80%, incurring high ratio insurance premiums.

What should you do? If you are considering refinancing your mortgage then give me a call. Given current market conditions, sooner will be better than later!

- Excerpts taken from Canadian Mortgage Trends

Your expectations are that everything will be approved without a hitch or will it?

If you are a salaried employee and have recently taken on a new position and you are still under job probation – there will be an issue qualifying with lenders.

If you are a self employed individual and have registered your business for  5 years or more, you now have to qualify using your Line 150 income and may gross up your income by 15%.  For individuals who qualified under a self-declared income program previously, this new legislation could be problematic.

If you are on maternity leave, lenders have different perspectives on what income they will use to qualify your financing.  e.g. Some lenders will use a percentage of your previous annual income to qualify while others will use only your employment insurance income

If you recently have lost your job, you may not qualify at all.

You know what “they” say about making assumptions …