Rising rates creating increasing dilemma for homeowners

Garry Marr
Financial Post


The interest rate dilemma has arrived again for homeowners.

What once was a no-brainer decision, locking in your mortgage rate for five years or even 10 years, now has a question mark attached to it.
 Blame the U.S. federal reserve for easing up on its bond buying program. Bond rates have climbed fast and mortgage rates are just following.

Variable rate mortgages, which track prime and are vulnerable to Bank of Canada decisions, are still being offered at about 2.6% for five years. But instead of competing with a 3% fixed rate five-year close mortgage, the competition is a 3.5% product.

It may be just 90 basis points but on a $500,000 mortgage, that’s not small change. Based on a 25-year amortization and $500,000 mortgage, the 2.6% variable would mean monthly payments of $2268.35 and about $60,000 in interest on a five-year term.

The 3.5% product means a monthly payment of $2496.36 and about $81,000 in interest over the term.

Once again it’s the first-time buyer, who is on the edge of being able to crack this market, squeezed out.

“It’s hurting them but also benefiting the rental market,” said Benjamin Tal, deputy chief economist with CIBC Markets.

Mr. Tal said the surge in the housing market we are seeing happens every time there is a fear of rising rates — consumers try to get into the market before it’s too late.

“I’m hearing a lot about people trying to blend and extend,” said Mr. Tal. Under that scenario, consumers contact their bank before their mortgage is due, hoping to extend their current loan at today’s still historically low rates.

If anything, the gap might widen between rates for short-term and long-term mortgages, after being historically low. “It means sensitivity to interest rates will rise because people will go to what is affordable,” said Mr. Tal.

None of this will likely make Jim Flaherty, the finance minister, happy. His government has gone to great lengths to slow the market and wants people locked into long-term mortgages so they don’t face the shock of suddenly rising rates.

What has gone on is the discounting has shrunk. It’s absolutely sneaky and it’s done on purpose

One of Ottawa’s subtle rules changes was to allow consumers to qualify for a loan based on the rate on their contract as long as they agreed to lock in for five years or longer. If you go with a variable rate, you must qualify for a loan based on the much higher 5.14% posted rate for a five-year fixed closed mortgage.

The Canadian Association of Accredited Mortgage Professionals found that in 2012, 79% of new mortgages were for a locked-in product, 10% for variable and 11% a combination of the two. Ottawa’s rule changes had an impact on those numbers but so did the deal of a lifetime on a five-year mortgage.

Jim Murphy, chief executive of CAAMP, wonders about what the impact of higher rates will be for new buyers when stacked on top of tougher rules.

His groups pointed out this month that sales for homes under $400,000 in the greater Toronto area were down 18% in May from a year ago. For homes priced above that level, sales were down just 5%.

“All of these changes have impacted the first-time buyer,” said Mr. Murphy. “Now we are seeing rising rates and that will have an impact too.”

Vince Gaetano, a principal at monstermortgage.ca, said the gap has become wide enough to convince him to go variable now.

Strangely enough, banks have not moved quickly to change their 5.14% posted rate — the percentage nobody actually accepts but which everybody qualifies based on.

“What has gone on is the discounting has shrunk. It’s absolutely sneaky and it’s done on purpose because they don’t want to move people away from not qualifying at all,” said Mr. Gaetano.

Another reason the banks don’t want to change the posted rate is it’s used to calculate any penalty on your mortgage. A higher posted rate would shrink your penalty, said Mr. Gaetano.

“It’s a very cleaver way for the banks to keep the handcuffs on people,” he says. “I still see people just break their mortgages outright. Variable is attractive too because of all the games banks play with breaking mortgages and penalties. With a variable mortgage, it’s three-months straight and simple.”