<Sigh>

Banks and service charges. Never was a more larcenous crew allowed to publically ply their trade until the banks got into the mix. With credit increasingly hard to get, TD has taken the step of now charging a $35 annual “inactivity” fee. Also, for those people that ARE using their lines of credit, the rate is rising from 3.9% to 4.4% above TD Prime Rate. BMO has also stepped up and increased interest on their lines of credit. Some people within the banks are saying that there is a cost to keep lines of credit open, even if you don’t use them. While this is true, it was never an issue before, but mounting loses in the financial sector, and tough lending costs to banks, has them passing the cost along to us.

WHEN PRIME RATE FALLS, OUR RATES DON’T ALWAYS FALL AS WELL

Every time there is the announcement that the Bank of Canada is lowering rates, my phones light up with calls with people wondering why their rate hasn’t fallen on their lines of credit, or mortgage, or what have you. The reality is that the banks must earn a profit on their business, or they won’t offer the product. With prime rate falling to record lows (currently 3% at most banks) the cost to borrow has never been cheaper. However, in an effort to make up some flagging profit margins, the banks are raising the discount from below prime to prime plus some amount. For example, lines of credit (secured) were typically prime rate for the past several years. With prime rate now soooo low, banks aren’t making enough money on the lines of credit to warrant servicing them. They are increasing rates anywhere from 1% to 2$. Sure, it’s still tied to prime rate, but now it is prime plus 1% up to prime plus 2% depending on your institution.

Bottom line: we can’t expect rates to fall forever. Eventually, the profit initiative will kick in. I’ve been shaking my head every time prime rate falls and the banks all scurry to follow the Bank of Canada. I’ve been calling for a while now that discounts will be eroded on lines of credit, and given that they are an OPEN credit facility, the bank can change the rates on you at any time, just like you can pay it out at any time and walk away. In the eyes of the bank, what is good for the goose, really is good for the gander.

I am re-publishing below, the article written by Sarah Schmidt in the Vancouver Sun:

____________________ Begin Article____________________

OTTAWA — Despite interest relief from the Bank of Canada, at least two of the country’s big banks are
increasing the borrowing cost for customers who tap into their lines of credit, and one is charging a new fee for those who don’t use it.

TD Canada is introducing a new $ 35 “ inactivity” fee in April for customers who don’t use their unsecured line of credit over the course of a year.

For those wo do, the interest rate is rising from 3.9 to 4.4 per cent above TD Prime, beginning March 1. The Bank of Montreal is also raising the borrowing cost for its unsecured line of credit by one per cent, from two to three per cent above BMO Prime, beginning March 4. The bank is not introducing any penalty fee for customers who don’t use their line of credit.

The changes were revealed in private correspondence to customers in recent days, just as the Bank of
Canada on Tuesday chopped its key lending rate by 0.5, to 1 per cent.

The banks, along with the rest of Canada’s big banks, immediately announced they were passing on the full measure of the latest interest-rate relief by cutting their prime lending rates by a half-point to a record low of three per cent.

The banks also announced reductions in some fixed and floating-rate mortgages. In a statement, a TD spokeswoman defended the decision to raise the cost of borrowing on its unsecured line of credit, saying it reflects “ the continued rise in the cost of lending.” Kelly Hechler added, “ We are working to balance our customers’ goals with prudent business practices, which is especially important during the current economic downturn.”

She also said the new penalty for inactive files is fair because there is a cost associated with maintaining them.

BMO spokesman Paul Gammal said despite the increase, the bank’s unsecured line of credit remains an attractive product for consumers. “ From our survey of the market, our personal-line-of-credit offering is competitive and, in fact, favourable, compared to some of our major competitors.”

Glenn Thibeault, consumer affairs critic for the New Democrats, wasn’t moved by that defence.
Thibeault singled out TD’s new inactivity fee as egregious. “ That one to me is just mind-boggling. You finally pay off your debt, and you get penalized for it.” A spokesman for Scotiabank said the company does not currently charge nonactivity fees on its lines of credit. He also said he would not speculate on any possible future interest rate changes. RBC and CIBC could not be reached for comment about whether their borrowing costs on unsecured lines of credit will be rising alongside TD’s and BMO’s.

_____________________ End Article____________________

So what do you think? Banks win again. Common theme to this blog lately…

With all the economic problems in the world, Canada has not been immune. There are many ways that the government can stimulate the economy: monetary policy, fiscal policy, massive spending programs, taxation, tax breaks, etc…

Today was the release of the 2009 budget, and it contained many nuggets for Canadians as the government tries to inject capital, spending, and tax breaks into the economy.

A couple of highlights include the following:

1. The basic personal tax exemption (the amount we can earn before paying tax) was increased from $9,600 to $10,320.

2. Creation of a Home Renovation Tax Credit that will provide up to $1,350 in tax relief for home renovations between January 27, 2009 and February 1, 2010. Approximately 4,600,000 families are expected to benefit.

3. $200 billion injection into the capital markets to improve access to credit and liquidity.

4. Protecting the serverance pay for employees when companies declare bankruptcy.

5. Additional housing for seniors, disabled, and natives on reserves to the tune of $1,000,000,000.

6. Making the construction and building application process more streamlined and efficient.

7. Cabinet ministers and their staff can no longer fly business class for trips under two hours.

8. 100% Capital Cost Allowance for all computers and software purchased over the next two years.

9. Small business tax cap increased from $300,000 to $400,000 in revenue.

10. $200 Billion in government financing made available to businesses to improve credit liquidity.

Some of the changes directly impact real estate and first time home buyers in particular. For example, first time home buyers will now be able to take out $25,000 of their RRSP (tax free) as a first time home buyer withdrawal. At the same time, the government will be willing to provide up to $750 in tax relief to first time home buyers to help cover closing costs. Additionally, the renovation tax relief will be a 15% tax credit on all renovation spending to homes over $1,000 up to $10,000. This includes renovations to substantially improve a home – the structure or building – not appliances and furniture or other items that could be taken from house to house.

The way the $750 tax credit works is a little convulted (as are all government programs where tax relief is offered in lieu of cash). The government will allow a $5,000 n0n-refundable income tax credit on qualifying homes after January 27, 2009. For someone that is eligible, that means up to $750 in tax relief. You will have to consult the new budget for more details on this program.

MY OPINION OF THESE CHANGES

There is no doubt that these moves will inject billions into the economy, and will hopefully grease the wheels of lending and liquidity to get businesses and individuals borrowing again. However, some of the changes, such as the $750 tax credit seem rather like a small drop in a very large pond. While I believe the government’s and legislator’s heart is in the right place, I have never seen a deal live and die (nor a person’s financial strength) swing from good to bad on a $750 tax credit. I would much prefer to have individuals qualify, up front and prior to closing, and have the government direct the funds right to the solicitor. This would be a $750 lump of cash that first time home buyers can feel! While I understand the benefits of tax credits, I also feel that making people pay up front, and get credited later, is a plan where the effect gets lost in translation. It is sort of like saying that you owe $2,750 of tax, but we’ll credit you $750 so you only owe $2,000. A good tax break, to be sure, but wouldn’t it have been better if the citizen got to keep the money in their pocket when they earned it rather than have to wait all year (earning no interest) and gotten it back later? Perhaps that is my personal bias coming through…

A DROP IN THE WELL WHICH HATH ALREADY RUN DRY?

As I read and re-read the government injection billions into the system, and making financing for business available, I hope that all this isn’t like throwing a cup full of water down a very dry and already empty well. My personal feeling is that the lending markets (particularly mortgages) got way, way, way ahead of themselves and ahead of prudent lending practices. Those debts don’t just go away, and while it is nice that borrowers now are going to be able to take advantage of some new financing, those debts (and all associated payments) are still due and owing every month. The problem isn’t JUST that financing isn’t available, it is that the delinquency rate on debt already funded (under the old loose guidelines) is still out there and needing to be paid. I think that this is the beginning of a long, slow descent for property values, and that anyone thinking of buying an investment property should think long and hard before doing so. I myself am looking for a single family home at this point, and this in spite of my thoughts that prices may fall. Why? Because ultimately, I need a place to live, and I will build up equity through the only way that I know how: hard work. It’s the only way I know how to pay back debt, and this country (though not as bad as the US) has a lot of hard work ahead of it.

I applaud the government for taking these steps as it means they DO realize how dire the situation in the credit markets really is. Now, we get to see if this massive cash injection can make a dent in a market already pounded flat.

Happy investing!

In the past two weeks, we have seen rates drop from around 4.99% on a 5 year mortgage to 4.29% – a move of over half a percent. For many lenders, the move was even more dramatic as they started out in the low 5’s and ended up at 4.49%. This is the largest rate drop in this short a period of time that I have seen in the past few years, but amongst all of it, one bank is offering a term deposit rate of 8% on a 5 year term. Eight percent! So how can they do this unless they clearly think rates are going to be going back up above eight percent? Let’s look at their offer, and see if we can infer where they suggest rates may be headed on mortgages at the same time.

TD Bank’s Offer of “5 Year Stepper GIC”

Year 1 – 1.80%
Year 2 – 3.50%
Year 3 – 4.00%
Year 4 – 4.50%
Year 5 – 8.00%

5 Year Average = 4.36% (Annual Interest)

5 Year Current Mortgage Rates = 4.54% through TD Bank (converted from 4.49% semi-Annual Interest to annual interest for comparability purposes)

NOTE: Term deposit is FULLY REDEEMABLE each year on the anniversary date.

So apparently, the bank is giving you 4.36% and only charging 4.54% ? This means that on $1,000,000 of business they are only making $1,800 per year? People often say that banking is a volume business, but even if they do $100,000,000 of business they still only make $180,000 of profit, and that is before expenses. Clearly, something more is going on here. The bank MUST be making money somewhere else, or, pardon the pun, banking on a higher return somewhere down the line.

ANOTHER SOLUTION?

Another alternative is that the bank is hoping that people do not hold their term deposits for 5 years, and that rates will begin to rise between now and then (in the early years of the term). For example, if, one year from now, rates on term deposits and mortgages are in the 6% range, and the client is in the second year of this term (3.50%) they may be inclined to cash out on the anniversary date and re-lock in at the new higher rates. Having been in banking and finance for 9 years now, I have seen this type of product before where banks hope that clients will not hold for the full 5 years. However, just like most situations, even if the rates rise this is a win-win situation for the bank.

Why? Because their yield, even if the client holds it for all 5 years, is still only 4.54%. So here is how the bank profits and an explanation of the only situation they may lose:

1. If rates RISE, clients may cash out and get into the new higher rates. Bank doesn’t pay 8% in year 5, and gets the money for the early years at 1.50% – 3.50%. Bank wins.

2. If rates RISE, but client does NOT cash out, the bank only pays the average over 5 years of 4.54% annually. If rates have risen, this is comparatively low. Bank wins.

3. If rates FALL, clients will stay in, earning 4.54% over 5 years and 8% in year 5. Some clients will still withdraw funds due to life situations, but overall, the bank loses in this scenario.

A further note: interest rates are near (or at in some cases) all time historical lows. In other words, there is a lot of room upwards, but not a lot of room downwards in interest rates. The general consensus amongst industry professionals is that rates will remain low in early 2009 to stimulate a sagging economy, but will rise (possibly dramatically) in late 2009 and for a prolonged period of time. Given this information, it seems very very likely, that either option 1 or option 2 (rates rising) will come into effect, and the bank will win again. Some things never change, do they?

Bottom line: I think this is a brilliant marketing strategy by TD Bank. They are utilizing their treasury, and a unique interest rate environment, to profit from potential rate increases which everyone seems to think are just around the corner. With such a large likelihood that rates will rise, this is a well informed bet by TD combined with a marketing gimmick that is sure to bring them additional business. However, the savvy investor will likely want to look elsewhere as being on the losing end of a heavily favoured bank bet is never a great investment.

I took three calls today from clients looking to finance the purchase of a property that had a main floor and three suites. All three clients were calling me about the same property they had seen on Craigslist. The house essentially had 4 units (if you rented it all out), and even if you lived on the main floor, was collecting $2,500 a month in rental income!

May clients saw this, and used my mortgage calculator, and found that $2,500 a month would support over $540,000 of mortgage (at current “best rates”). The price on this home is only $550,000 so even with little out of pocket (5%), they could live without having a mortgage payment of their own! This is an astute observation, but, what they fail to account for is that banks do not treat rental income the same way as clients.

There are THREE problems with this house (from a financing standpoint):

1. The suites are illegal (non-conforming and/or non-reported)

2. Banks do not give you 100% credit for rental income

3. Less than 20% down payment is being offered

ILLEGAL SUITES

If you are purchasing a home that has a rental suite, it generally needs to be “legal” in order for banks to use the rental income when qualifying you for a mortgage. Why? Because illegal suites CAN BE SHUT DOWN. The city may decide that, due to pressure from lobbyists, neighbours, city planners, current property or income tax laws, or a myriad of other factors, that they want to put an end to illegal suites. If this happens, and someone reports you (a neighbour aggravated about parking difficulties in the area due to all the renters, for example) , the city may crack down and have you remove the illegal suite.

There are some other reasons they may do so: zoning, fire hazard (do you have adequate parking, sprinklers installed, avenues of escape from fire, etc…?) The bottom line is that illegal suite income is fairly certain but not GUARANTEED. As a result, lenders (usually) only use illegal suite income when the government isn’t involved. If you are buying a property and putting less than 20% down, you will usually require CMHC insurance. CMHC, a government body, will not use illegal suite income to help qualify you for a mortgage. Therefore, you will need more than 20% down payment to keep CMHC (ergo, the government) out of your mortgage application. In these cases the mortgage is referred to as a “conventional” mortgage, and is subject only to the individual lender guidelines: not the government. For those very well informed, or inside the industry, yes, there are other mortgage insurers than CMHC, but not all lenders use them and even their treatment of rental income has been curtailed lately.

Lastly, if suites were reported, legal, and conforming, the government would charge more property taxes due to the higher level of density and occupancy of the property. Property owners, hoping to avoid property taxes, often (99% of the time) do not disclose the suite in the property to the city for fear of paying a higher amount of tax. However, the downside to tax avoidance, is that your application is weaker in the eyes of the bank and CMHC (no use of the illegal suite income will be used).

Even though the property has $2,500 of rental income from the 3 illegal suites in the basement, in many cases, the bank will ignore that rental income when looking at your application.

BANKS NOT GIVING 100% CREDIT TO RENTAL INCOME

When an applicant looks at $2,500 of rental income from a property, they assume they will get $2,500 of money per month to put towards mortgage payments. Most times, they are absolutely correct. However, there are times when you have a vacancy due to a myriad of reasons: maybe a tenant leaves and provides no notice, or maybe the last tenant trashed the unit and it will take some time to repair it. Maybe you fail to collect rent one month as your renter just doesn’t have the money. There are a number of reasons that you will not collect 100% of rent 100% of the time

If the suite is legal, we can generally get a lender to give you credit for 80% of the income from the basement suite – even with as little as 5% down payment. However, if suites are illegal, they will ignore the rental income.

If the suite is illegal, but you have 20% down payment (thus keeping CMHC and the government out of your mortgage) then we can generally get the bank to give you credit for 70% of the rental income.

So, using my initial example of $3,100 affording $650,000 of mortgage, the banks will only give you credit for 80% of $2,500 or $2,000. This lower number only supports $430,000 of mortgage. This means that the person’s personal, taxable, income will have to support the balance. If they declare little or no income, or file no taxes, this may not be possible.

Vacancy and repairs are just one reason that the lender only gives you 70% – 80% credit for rental income. There are numerous other reasons: snow removal, having to put on a new roof, install a new furnace or hot water tank, vandalous tenants, increases in property taxes, increases in heating costs, or virtually any other “variable” in your housing costs.

LESS THAN 20% DOWN PAYMENT IS BEING OFFERED

I cannot stress this point enough: if you have less than 20% equity in the property, and the suites are illegal, then you will not be viewed favourably by the banks. With respect to the property currently on Craigslist with $2,500 of rental income, I have heard all three clients that called me say, “but the bank said they will look at the rental income of those suites,” and the reality is THEY WILL, but only if the applicant has 20% equity in the property.

Less than 20% equity in the property subjects the borrower (and bank – ANY bank) to CMHC rules, and CMHC rules (government rules) so that no rental income will be given consideration from an illegally operated (or non-conforming) suite.

BOTTOM LINE: If the deal seems so perfect, and the rent will totally cover the mortgage, then ask yourself two questions: why are they selling? and why hasn’t someone else already thought of this?

This was an article forwarded to me today from the Financial Post. It is a good read on what effect the prime rate drops are having, if any, and how the economy is Canadian industry and finances.

Canada finds itself in a ‘credit deadlock’

Jacqueline Thorpe, Financial Post  Published: Tuesday, January 20, 2009

What if the Bank of Canada cut interest rates and nobody borrowed? As the Bank of Canada joins other central banks around the world in slashing interest rates to historic lows, this is the essential conundrum they face.

They may have brought some semblance of normality to credit markets, and harangued banks back into lending, but now borrowers are on strike.

Call it a “credit deadlock,” as David Laidler, fellow-in-residence at the C.D. Howe Institute, does, or a shift from “aspirational to desperational” spending, as Goldman Sachs quipped Tuesday, but the fact is people are becoming less willing to borrow and spend, even if the Bank of Canada’s benchmark interest rate is now a tantalizing 1%, the lowest policy rate since the Bank of Canada was founded in 1934.

If consumers were getting antsy about spending as house prices and stock prices tanked, they are hardly going to start borrowing and spending if they are now also losing their jobs.

The United States is now well into this consumer deleveraging process as the unemployment rate has risen from a trough of 4.4% to 7.2% in the space of little over a year.

In Canada, the process has only just begun. For a while, it looked like we might be able to skate through the slowdown with just a flesh wound or two but the complete and total collapse in commodity prices has put paid to that notion, as news Tuesday showed.

Manufacturing shipments for November fell 6.4% to $48.4-billion in November as commodity prices plunged. Strip out the price declines and volumes were still down 3% and new orders plummeted 12.9% as U.S. demand froze.

Meanwhile, Suncor Energy Inc. reported its first quarterly loss in 15 years, chopped spending plans for the second time in less than three months, and indefinitely postponed its oil sands expansion plans as oil has cratered to US$39 per barrel from its peak of US$147 in the summer.

We may have a healthier financial system than our G7 colleagues but our G7 colleagues haven’t seen their golden goose vaporized in the space of six months.

That goose — all natural resources combined — accounted for all the growth in Canada’s export earnings from 2004 to 2008 (non-resource exports slumped 17% on the back of a strong dollar and a drop in auto sales) half the value of the S&P/TSX until the third quarter of 2008 (up from 20% in 2003); and half the growth in business investment from 2003 to 2006.

The goose has not been a big jobs or GDP generator on its own since it is so capital intensive, but the boost to national income from the longest and steepest commodity boom in the post-war period has been phenomenal, stoking profits and the Canadian dollar which have been recycled back to consumers in the form of tax cuts, lower import prices and higher disposal income. That in turn has boosted jobs and income growth all down the pipeline.

Canadians were not afraid to take on ever-increasing debt under this rosy scenario.

But it has all vanished now. A report from BMO Capital markets Tuesday said many commodities such as copper and zinc are now trading below their average operating costs, let alone their all-in costs.

As we wait for other sectors to pick up the slack, the job losses will mount and the opposite, negative dynamic will take hold.

That is not to say the rate cuts will have no impact at all. They will help the banks, which dutifully passed on the cuts through a drop in prime lending rates to 3% from 3.5%. Those with variable rate mortgages and lines of credit will benefit.

An FP colleague who renegotiated her mortgage in September says her mortgage rate — prime, minus 75 basis points — will fall to an astonishingly low 2.25%. But she is not about to go out and run up her line of credit. People in general will try to cut back their debt and shy from fresh borrowing.

And while the Bank of Canada forecasts growth will rebound to 3.8% in 2010 from a contraction of 1.2% this year, debt workouts are usually long and painful as anyone who has watched them in the corporate sector knows.

This article came across my desk today from one of my lenders, and it told a number of largely unreported truths about the credit market that taking place. Many of these changes are not being reported on by mainstream media, and consumers should be made aware of these changes.

Tight credit starts to bite consumers

TARA PERKINS AND LORI MCLEOD

From Saturday’s Globe and Mail

January 16, 2009 at 9:10 PM EST

The credit crunch, which has already squeezed corporate borrowers, is now trickling through to consumers, with higher interest rates and tighter lending terms.

Some borrowers are being notified that rates on their credit lines and cards are going up, and others are having borrowing limits scaled back.

Home buyers taking out a variable-rate mortgage, meanwhile, will find a premium over the prime rate of 70 to 80 basis points, rather than the discount they might have found just six months ago. (A basis point is 1/100 of a per cent.)

While financial institutions in the United States took similar measures last year and banks in Canada have been charging their corporate customers more, the competitive consumer-banking environment in Canada has made it more difficult for Canadian lenders to pass their higher costs along to individual borrowers.

But signs are mounting that financial institutions are going to raise prices on consumer loans, even as the federal government attempts to tackle the thorny issue of credit in its Jan. 27 budget.

Ottawa wants to grease access to credit at reasonable prices to keep the economy churning through the downturn.

The price of bank loans is also likely to hit the spotlight Tuesday, when the Bank of Canada is expected to cut interest rates again.

Banks are under pressure to reduce rates and lend more at a time when they are worried that more borrowers will struggle with their debts, a concern reflected in their increased provisions for troubled loans.

Bank of Montreal is sending letters to customers notifying them of a 1 percentage point increase in interest on lines of credit. The prime rate has been declining in recent months while the cost of borrowing has risen dramatically for all banks, the letters say.

BMO’s increase, which affects customers who obtained credit lines before Oct. 15, does not make its products the most expensive in the industry. “From our survey of the market which was confirmed as recently as today, our personal line of credit offering is competitive and in fact favourable compared to some of our major competitors,” a spokesman for the bank said earlier this week. But the move signifies a new willingness among banks to raise rates.

“I think we’ll see the rest of the competitors follow suit in some fashion,” said Edward Jones analyst Craig Fehr. “I think this is going to be the first of many product lines that will get repriced.”

The banks, which fund more than half of their loans through deposits, are seeking to loosen the vise grip that lower interest rates have placed on their profits.

“Since the banks depend on deposits for much of their funding, if you reduce prime without being able to reduce deposit rates by the same amount, the margin gets squeezed,” said National Bank analyst Robert Sedran. “Increasing the borrower’s spread to prime restores some of that lost profitability. You could see more of that behaviour if interest rates continue to fall.”

Canadian Tire is raising the rate on its Options MasterCard credit cards by 2 percentage points, effective in March. A number of competitors have already raised rates, said spokeswoman Lisa Gibson.

“In this case, just given the economy and so on, we made the decision to raise it,” she said. Canadian Tire has also reduced the spending limits on accounts that were inactive in order to reduce risk in the company’s portfolio, she added. “We also stopped credit limit increases for riskier customers.”

American Express sent letters to a number of Canadians last month informing them the limit on their card had been cut. The company recently tightened some of its criteria, and has increased scrutiny of customer limits in light of the economic environment, said spokeswoman Lauren Dineen-Duarte.

One cardholder, who says she has never missed a payment and has a good job and credit rating, was surprised to receive a form letter from Amex Dec. 24 scaling back her credit limit by more than $16,000.

“These regular reviews are undertaken to protect card members’ interests by helping them avoid taking on additional debt that they may not be able to support,” said the letter, which informed the cardholder her limit had been reduced to $1,000.

Ms. Dineen-Duarte said that although “this is an area that is being given increased scrutiny at this time, we have currently only had to take action like reducing credit limits for less than half-a-per-cent of our total card member base.”

She added that Amex carries out its assessments based on the financial information it has on record, including the card holder’s spending and payment patterns, and external information it obtains from credit reference agencies.

As Toronto-Dominion Bank chief executive officer Ed Clark pointed out at an industry conference recently, there is new evidence that more Canadian consumers will have trouble repaying their loans. Personal bankruptcies and unemployment are on the rise, and soured loans are expected to follow.

As a result, financial institutions are stepping up efforts to reduce risk in their lending portfolios, and protect profits.

“Will we be able to start to recover, in the lending markets, our cost of lending?” Mr. Clark mused. “I think every bank is trying to do that, but this is a highly competitive market.”

He later added, “We’re going through every line of business and saying, ‘Okay, would you make this loan if you assume we’re going to have 8 per cent or 9 per cent unemployment?’”

Discounts on variable-rate mortgages, which had become standard during the housing boom but evaporated late last year, are showing no signs of a revival. Lenders are charging about a percentage point above prime on open, variable-rate mortgages with a five-year term. The best current deal is 60 basis points over prime, according to a mortgage broker.

In October, banks and other lenders stopped offering discounts off the prime rate on variable mortgages, and shortly thereafter began charging their mortgage customers a premium over prime.

While rates are historically low, the difference between receiving a discount and paying a premium above prime can translate into a 20-per-cent difference in the biweekly payment amount on a $300,000 variable-rate mortgage.

Very frequently, in the Vancouver market, people ask me if they should really be taking a 35 year mortgage when I hand them their approval. In their eyes, by paying the mortgage longer, they are going to be paying a lot more interest. However, we often have to sell 35 year mortgages not because we want to (we certainly don’t get paid more), but because we need to have the client take a 35 year mortgage in order to QUALIFY for the mortgage.

We need to first define two terms:

1. AFFORDING the mortgage

2. QUALIFYING for the mortgage

Many clients can afford larger payments than the banks think. Affording a payment is the ability to make the payment within the confines of a person’s true income. QUALIFYING is the process that banks do when they are assessing how much you can afford. Banks qualify you based on you TAXABLE income that appears on your T4 or Notices of Assessment. However, in a case of a self employed person, they may be able to “afford “a lot more than they “qualify” for because they may have a lot of tax write offs, deductions from income, and business related expenses. In this case, their income may only show $30,000 but in reality they may earn $100,000 a year in income. However, the bank only will use the taxable income of $30,000 when they “qualify” the applicant.

Let’s look at how this plays out in the real world. How much of a mortgage does a person earning, on paper (T4 or Notices of Assessment) $40,000 a year “QUALIFY” for versus what they can “afford” with their $100,000 gross income. For the purposes of this example we will assume they have excellent credit and no other debts outstanding:

$296,500          35 Year Mortgage
$278,200         30 Year Mortgage
$254,900         25 Year Mortgage

So in this example, the above person only “Qualifies” for $254,900 on a 25 year mortgage, but $296,500 on a 35 year mortgage. In this case, if they need to purchase something close to $300,000 they will HAVE TO take the 35 year mortgage in order to be approved, even though they know they can afford the 25 year mortgage payments.

So, let’s answer a few questions:

1. Can I change the mortgage from a 35 year mortgage back down to 20 years once my 5 year term expires? ANSWER: Yes, absolutely.

2. Once I start with a 35 year mortgage, am I stuck that way forever? ANSWER: No, at the end of your term you are working from a clean slate and can renegotiate and requalify at that time.

3. Even though I get set up at 35 years, can I make payments equivalent to a 25 year mortgage? ANSWER: Yes, absolutely.

4. If I make payments for a 25 year mortgage, even though you approved me at 35 years, do I pay more in interest? ANSWER: No. You pay no more in interest.

I would say that over 75% of the mortgages that I do are 35 years. Why? Because once set up at 35 years, you can always pay it down faster. However, if you set up a mortgage for 20 or 25 years, and then run into financial trouble, you cannot go to a 35 year payment without redoing your mortgage and suffering a penalty. If we set you up for a 35 year mortgage from the beginning, you can always go back to the 35 year payments.

For example, if you bought a $300,000 home, and took a 35 year mortgage (even though you could afford a 25 year mortgage) your minimum payments for a 35 year mortgage would be around $1,485 per month. However, if you wanted to pay it down in 25 years, you would be able set you payment at $1,726. Subsequently, 2 years down the road, you decide you want to go back to the 35 year minimum of $1,485 you can with a simple phone call or email (no penalty would apply). However, if you opted for the 25 year mortgage initially, and wanted the 35 year payment, you would have to restructure the entire mortgage, absorb a penalty, and suffer the financial loss.

For this reason alone, most people opt for a 35 year mortgage, and set the payments at 25 years so they pay it off faster.

If you require more information on this strategy, please call me at 604-657-6775 (cell) or on my email at smith.rowan@mortgagecentre.com and I can advise what the best option is for you in your unique financial situation.

So Canada Prime Rate has fallen again, and the word in the media is that it will fall again. So, mortgage rates are going to fall again, right? Not necessarily.

The purpose of today’s article is to discuss where rates are, where they are going, and what is driving the current rate environment.

Let’s start off by putting what the best rates I, as a mortgage broker, can get for my clients:

1 Year – 4.00%
2 Year – 4.94%
3 Year – 4.69%
4 Year – 4.69%
5 Year – 4.44% ** See caveats below
Variable OPEN – Prime + 1%
Variable Closed – Prime + 0.60%

** Caveats for 4.44% are as follows: applicants must have ONE of the following:
- $150,000 combined income ON PAPER (taxable)
- $150,000 investable assets OUTSIDE of the down payment on this property
- $500,000 mortgage amount or greater on the deal they are applying for
** Failure to meet these criteria results in the next best rate of 4.49% (4.89% on pre-approvals)

So what should you take? Well, that depends, and for me to properly advise you I would need to review your situation in a little more detail. However, a couple things stand out to me. First, we are about 25 BPS (0.25%) off the lowest historical rates in Canada. There is not a lot of room down, but there is a lot of room upwards, and with rates like that: at 4.44% for 5 years, I think taking some longer term money is a good idea. The best rates at prime + 0.60% (4.10%) expose you to upward risk for not a huge savings, and come with a few other “catches” that you have to be aware of (for example, you cannot refinance out of that mortgage for the first three years unless there is an arm’s length sale). With fixed rates being portable, assumable, and darned low, this is a good time to lock in and rest easy while the market remains in flux.

Comments?

I have been taking more and more inquiries about foreclosures lately as people are looking for a good deal. The media, in particular late night TV, has glorified foreclosures as a method of finding amazingly discounted properties at low prices, that you can buy up below market value, and reap the rewards. While this opportunity exists, it really exists more with PRE-FORECLOSURES than with Foreclosures.

Here is the general policy with a foreclosure. It is important to understand this process, as you will then understand that by the time you get wind of the foreclosure from public information such as MLS data, the opportunity to buy it below market value will likely be passed.

PRE-FORECLOSURE PERIOD

Generally, lenders do not advertise when their clients are in arrears. This has everything to do with privacy laws, and also, people DO get caught up sometimes. Lenders try to give their clients the benefit of the doubt, and they don’t initiate foreclosure proceedings the moment the homeowner goes into arrears. They usually give them somewhere between 2 and 3 months to get caught up.

This is the best time to buy a pre-foreclosure. Usually, the borrower knows they are in financial difficulty (they aren’t able to make payments) and all sorts of things will be running though their head: refinance? Sell and pay out the mortgage(s)? Get a roommate? Etc.. All this will have them worried. Oftentimes, during this period they may not be doing all the required maintenance of the house as they scramble to try and get money put together for mortgage payments.

IN FORECLOSURE

If the arrears continues for 2-3 months, the lender will petition the borrower into court, and will request an “ORDER NISI” which is a ruling that if the borrower doesn’t “redeem” (pay their arrears) within 6 months from the date of the Order Nisi being issued, then the mortgage holder (lender) can take over the property, evict the owner, and sell it or rent it out for their own profit. Once the 6 months is up, the court will issue an “ORDER ABSOLUTE” which hands the house (and any remaining equity) over to the lender. It becomes the lender’s property.

Throughout this 6 month period of time, we call that being “in foreclosure” as it is during the process of foreclosing (lender taking over the property).

COURT ORDERED SALE

This is usually part of the foreclosure process, but only comes up when the lender’s equity is threatened. For example, if the lender does a mortgage for $375,000 on a $400,000 home with $2,500 a month payments, then this means that it will take 10 months (25000 / 2500)  of late payments before the equity is wiped out due to accruing interest and the lender starts losing money. Now assume the market value slips by 5% (VERY normal) that leaves only $5000 equity in the property meaning that if the client is 2 months in arrears the lender’s position is wiped out! If the client is going to get 6 months to redeem and get caught up, the lender could lose a LOT more than their initial investment (their investment is your mortgage)!

In this situation, if it appears that the lender will lose money, they can approach the court and ask for “Conduct of Sale” meaning they are allowed to list the property (with a realtor of their choice) and sell it. You can tell if a listing on the MLS from your realtor is a Court Ordered Sale by looking at the portion where it says “Owner” and if it is a financial institution’s name on there, you can be assured it is a Court Ordered Sale.

So, the court has ordered the sale, and the lender desperately wants to sell. You can get a great deal on this property, right?

WRONG! Any sale has to be okayed by the court. There is typically a day where your offer is read into court, along with any other offers, and the court awards the highest. I have seen it, many times, where the property ends up going for MORE than market value as buyers get swept away in the heat of competition and the emotional process of buying their home!

Bottom line: just because it is a court ordered sale, doesn’t mean it will go for a low price. Oh, sure, it COULD be a great deal if you are the only one offering the price, but this is ultra rare in Canada (common in the US) as most buyers and realtors are very savvy on this process here in Vancouver due to our high prices and recent massive price run up.

POST FORECLOSURE

Once the lender has foreclosed and taken title, they can then sell the property, live in it, rent it out, or do whatever they wish. It is their property now. During this period of time the property will typically go up for sale on the MLS system in your area. The lender will usually just want to get whatever their mortgage money is back and move on, so they MAY accept a slightly lower-than-market-value offer for the property if they can quickly sell and get their money back. Why? Because their money is tied up in the property and they could be lending it out and earning money on it in the marketplace with another borrower.

Once the property is sold, the lender takes all money required to pay them off, pay all lawyers, pay for all services relating to disposing of the property, and then they pay the remainder (if any) to the borrower. Typically, there is no leftover funds or the borrower would have found a way to pay the arrears to preserve the equity.

WHY LENDER’S FORECLOSE

In times of stable or rising markets, the 6 months is usually allowed to pass before the lender gets aggitated. However, if the arrears and late payments are really adding up, and if it appears that the lender may take a loss the longer this process goes on. Why will they take a loss? I have been in this situation as a private lender, and this was how it went:

The client came to me and asked to borrow $20,000 as a 2nd mortgage. Their home was worth $440,000 and they had a 1st mortgage with a Trust company for $350,000 and payments of interest only for $2,750 per month. I agreed to lend them the money as they were a few months in arrears and needed some cash to do some renovations to install a suite in the basement that they could rent out and earn an additional $700 per month.

I agreed to loan them the money, and they bounced the very first cheque! And the second! I got contacted in month three by the 1st mortgage company who told me they were initiating foreclosure proceedings as they were not getting paid either!

I looked over the numbers, and there was a LOT of equity, so I wasn’t worried. However, then the market took a shift lower (September 2008) and lost 10% almost overnight!!! The property went from $440,000 to $396,000!!!

The client had the following situation arising:

$350,000 1st mortgage
$5,000      Arrears on 1st mortgage
$20,000   2nd Mortgage
$375,000  TOTAL DEBT (Before realtor commissions and legal costs)

I saw the writing on the wall and immediately requested Conduct of Sale so that I could sell the property, pay out the 1st mortgage, and get my money back. We were awarded Conduct of Sale and put it on the market for $379,000 to get a fast sale. No luck.

It’s been on the market for months, and as of this article, it appears that I will be losing the money I loaned to these people.

So why did I lend it, you may ask? The clients came to me desperate. The wife had just recovered from liver cancer and was back at work. Both husband and wife were working full time jobs that made JUST enough for them to cover their payments. Plus, they were going to renovate and put a suite in so they would be able to earn $700 more per month. We had cleaned up all the issues on their credit, and at 78% financing it looked like a safe deal. In hindsight, it taught me a valuable lesson about lending and why foreclosures aren’t a great deal all the time:

1. The property was in poor repair by the time I got conduct of sale as they had done no maintenance in the past couple years

2. The arrears were stacking up on the 1st mortgage and ultimately wiped me out.

3. The market can move quickly and far

So, if someone were to come along today and offer to buy that property off of us, we would sell it at a tremendous discount and someone could get it for a great deal! However, we are not going to spend money to advertise it as we are already losing our investment, so unless someone knows about me, my business, or this blog, they will never know what a great deal is sitting out here or how desperate the sellers really are.

The only want to get quality information on foreclosures is either to:

1. Work with a foreclosure lawyer who is willing to forward you their list of foreclosures

2. Get in with a mortgage broker (such as myself) who can tell you of clients in PRE-foreclosure

3. Listen to people that are going through divorces, deaths in the family, etc… as they often have a need to get rid of property soon as they may be distressed and going to lose it

4. Look at the court docket for what is appearing – you have to go to the courthouse everyday (or know how to dig it out online – not easy) and see lots of “John Smith vs. TD Bank” and “Ray Horshman vs. Capital Direct” or other such things. When those people leave the courtroom, TALK TO THEM.

Other than this, there is no LIST of foreclosures, and certainly no list of PRE-foreclosures. It takes research, hard work, or connections (usually the latter) to find gems amongst the PILE of deals in foreclosure.

Happy investing!

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