Well, it’s happening again… In a bid to get more mortgages, some lenders are now offering super low rates on their 5 year mortgage, but are eliminating the pre-payment flexibility and payment options in a quest to entice people to get their mortgages.

For example, one lender is currently offering 3.59% on a 5 year mortgage. With everyone else at 3.69% or 3.79% it sounds like a great deal. As people, we like to have clear things that we base decisions on, and numbers represent something that we can all “hang our hat on” and understand. So, to the average person 3.59% sounds better than 3.69%, right?

Not necessarily.

Oftentimes, lenders have a number of restrictions with these mortgages that they dub as “No Frills” or “Value” or some other such moniker that, on the surface, to the average consumer, sounds great. There are “no free lunches” in banking and finance, and the banks aren’t stupid. They may offer a better rate, but they always get you in the end.

When we dig a bit deeper into these rate offerings we often (but not always) find one or more of the following restrictions:

1. ONLY Monthly payments are allowed. Bi-weekly payments may not be allowed and/or

2. NO pre-payments or lump sum payments are allowed AT ALL, or

3. NO pre-payments or lump sums are allowed unless there is a penalty, or

4. NO increases in payments are allowed

5. Mortgage may be fully closed to refinancing with anyone except the currently lender thus limiting refinancing options and choices of rates in the market.

6. Larger than normal penalties (possibly up to 6 months interest – or more – depending on the specific offer)

Most people look at the low rate and think to themselves, “well, I plan on living there for 5 years and then I can pay it off and have no penalty at that time.” In a perfect world where things like unexpected new spouses, new children, job transfers, and upgrades to larger homes don’t occur, this is fine. But, as they say, “Shit Happens,” and oftentimes the flexibility you don’t think you need becomes the flexibility that you gave up and pay heavily for down the road.

Let me explain an all-too-common situation. An applicant comes to me and I sell them on a NON No-Frills mortgage. This means they may get 3.69% instead of 3.59%. However, when I talk about pre-payment they block me out and really just focus on the stick price (the rate) to the exclusion of all else. Let’s further assume they are a young couple that is 27 years of age buying a one bedroom apartment. They insist on the 3.59% rate as it “saves them money.” How much money?

Well, assuming their 1 bedroom is $300,000 and they put 5% down, the savings for 3.69% and 3.59% is $16.92 per month. “That will buy me lunch once a month!” they are often heard to quip. If this is a 5 year term, they will save $1,015.20 over a 5 year period of time. Sounds good?

Well, they happen to be in the age that is most likely to need to buy a larger home (possibly having a child or pet or just wanting to upgrade). So, two years down the road, their mortgage is down in the $285,000 range and they see a place that is a STEAL and want to upgrade into it. They need to borrow $100,000 more, however, as this unit is more expensive. So they call the bank and find out that their penalty is 6 months interest instead of the standard three months. Had they taken a normal mortgage their penalty would be $2620 (approximately). However, as they opted for the low rate mortgage with “No Frills” that happened to have larger than normal penalties, they now face a penalty of $5,240 and this choice cost them $2,620 in exchange for a FIVE YEAR savings of only $1,015.20!!! Clearly, they would have benefit ted from a little more flexibility.

Some people will say, “buy MY bank doesn’t charge a higher penalty.”

Ok, this may be the case. However, most banks (at least any that I will sell a mortgage for) allow 20% of the “Original Mortgage Amount” to be paid out PENALTY FREE throughout the year. So, if their mortgage was originally $300K (for example) they can pay up to $60 penalty free. So here is the penalty the person with the ultra-low rate took will face:

Three months interest on the outstanding $285,00 balance
$2,620

The penalty someone with a normal mortgage will face is as follows:
$0 penalty on the 20% they are allowed to pre-pay ($60,000)
$2,004 three months of interest on the remaining $225,000

The savings to paying out the NORMAL mortgage versus the No Frills mortgage is $616.

“But I saved $1,015.20″ someone exclaims.

No you didn’t. You only got that savings if you carried the mortgage to the full 5 year term. If we are 2 years in (of 5) you’ve only saved 2/5 of $1,015.20 or in other words $406.08 so again, the person with the normal mortgage wins.

THIS IS GETTING COMPLICATED…
If there is one thing I want you to take away from this post it is this:

THERE IS MORE TO A MORTGAGE THAN THE RATE!

There are a lot of ways that banks get their profit, and a lot of it happens behind the scenes on the “back end” of a mortgage during payout.  I’ve provided a couple of basic examples of where the No Frills mortgages are harmful, and in my time as a broker, I’m yet to see a person for which they are well suited. I’ve never sold one yet. That isn’t to say that I won’t but that I will make damn sure it is the right product, for the right clients, and that they understand that there is more to this sophisticated and complex transaction than the sticker price (the rate).

Until next time, watch out for these products! If you see a rate you want me to dig into the terms for, let me know, and I’m happy to oblige.

So, despite the majority opinion that the Bank of Canada would not lower rates, they did! With the key lending rate now at 0.25% (down from 0.50%) the major banks immediately followed suit by lowering their prime rate to 2.25%. When I last checked, every major bank had lowered prime, and the rest were following as well.

While this news is shocking, the fact that the Bank of Canada has revised its economic outlook from a 1.5% contraction to a 3% contraction is the result of this change. With the overall prices in the market falling, and the economy shrinking, the Bank of Canada has indicated they will follow this low-rate policy through until the 2nd quarter of 2010. This is likely a sign that the ultra-low rates we are seeing currently, are here to stay, for the time being…

The reason for this change in outlook is the result of the global recession deepening (this should come as no shock, I figure), and prices of nearly everything being driven down due to soft demand and wary consumers.

Published below is the Bank of Canada’s official press release regarding the rate decrease. This was published today, April 21st, by the Bank of Canada.

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Bank of Canada lowers overnight rate target by 1/4 percentage point to 1/4 per cent and, conditional on the inflation outlook, commits to hold current policy rate until the end of the second quarter of 2010

OTTAWA – The Bank of Canada today announced that it is lowering its target for the overnight rate by one-quarter of a percentage point to 1/4 per cent, which the Bank judges to be the effective lower bound for that rate. The Bank Rate is correspondingly lowered to 1/2 per cent. The deposit rate – the rate paid on deposits held by financial institutions at the Bank of Canada – is left unchanged at 1/4 per cent and provides the floor for the overnight rate. Details of the Bank’s operating framework at the effective lower bound can be found here.

In an environment of continued high uncertainty, the global recession has intensified and become more synchronous since the Bank’s January Monetary Policy Report Update, with weaker-than-expected activity in all major economies. Deteriorating credit conditions have spread quickly through trade, financial, and confidence channels. While more aggressive monetary and fiscal policy actions are underway across the G20, measures to stabilize the global financial system have taken longer than expected to enact. As a result, the recession in Canada will be deeper than anticipated, with the economy projected to contract by 3.0 per cent in 2009. The Bank now expects the recovery to be delayed until the fourth quarter and to be more gradual. The economy is projected to grow by 2.5 per cent in 2010 and 4.7 per cent in 2011, and to reach its production capacity in the third quarter of 2011. Given significant restructuring in a number of sectors, potential growth has been revised down. The recovery will be importantly supported by the Bank’s accommodative monetary stance.

The Bank expects core inflation to diminish through 2009, gradually returning to the 2 per cent target in the third quarter of 2011 as aggregate supply and demand return to balance. Total CPI inflation is expected to trough at -0.8 per cent in the third quarter of 2009 and return to target in the third quarter of 2011. While the underlying macroeconomic risks to the projection are roughly balanced, the Bank judges that, as a consequence of operating at the effective lower bound, the overall risks to its inflation projection are tilted slightly to the downside.

With monetary policy now operating at the effective lower bound for the overnight policy rate, it is appropriate to provide more explicit guidance than is usual regarding its future path so as to influence rates at longer maturities. Conditional on the outlook for inflation, the target overnight rate can be expected to remain at its current level until the end of the second quarter of 2010 in order to achieve the inflation target. The Bank will continue to provide such guidance in its scheduled interest rate announcements as long as the overnight rate is at the effective lower bound.

To reinforce its conditional commitment to maintain the overnight rate at 1/4 per cent, the Bank will roll over a portion of its existing stock of one- and three-month term Purchase and Resale Agreements (PRAs) into six- and twelve-month terms at minimum and maximum bid rates that correspond to the target rate and the Bank Rate, respectively. These longer-term PRAs will be issued according to the schedule released today.

Today’s decision to lower the policy rate by 25 basis points brings the cumulative monetary policy easing to 425 basis points since December 2007. It is the Bank’s judgment that this cumulative easing, together with the conditional commitment, is the appropriate policy stance to move the economy back to full production capacity and to achieve the 2 per cent inflation target. The Bank retains considerable flexibility in the conduct of monetary policy at low interest rates, consistent with the framework to be outlined in the Bank’s Monetary Policy Report on 23 April.

Information note:

The next scheduled date for announcing the overnight rate target is 4 June 2009.

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I get asked every day if I think rates are rising, falling, or going to hold steady. Frankly, I don’t buy a lot of the opinions from experts. I prefer, instead, to look at where inflation is, what the Bank of Canada’s stance is on inflation, and make some inferences from there. Not a month ago, inflation had spiked, and the Bank of Canada was holding fast on their interest rates. Now, inflation has slowed, and the Bank of Canada has been given some room to drop rates further (yes, it is technically possible).

This article was written by Julian Beltrame, of the Canadian Press and is being reproduced in full with full credit to her for the work. This is just a republishing of the article, but it does indicate we may see more rate cuts in the future. All I can say is, WOW.

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Inflation is falling again, giving Bank of Canada governor Mark Carney a free hand to take the central bank’s trend-setting interest rate down another notch next week to an unprecedented low.

Consumer prices were up 1.2 per cent last month over a year ago, below expectations that the inflation rate would remain at 1.4 per cent, as cheaper gasoline and cars outduelled rising food and shelter costs.

The slower pace of overall increases tallied by Statistics Canada maintains a trend that began last summer when oil prices began receding from their historic peak and the global recession took hold.

Economists predict the headline inflation rate will soon tumble into negative territory as year-over-year comparisons take account of last spring and summer’s soaring fuel costs.

“The energy-price discrepancy between the spring and summer of 2008 and our forecasted levels point to a headline rate moving below zero,” commented Royal Bank economist Dawn Desjardins.

However, this does not necessarily mean that Canadians need to fret about deflation – a devastating downward move in general price levels that would ravage asset values, discourage consumption and slash production.

“I don’t think we have to worry about deflation,” said Benjamin Reitzes of BMO Capital Markets.

“Unless core prices go negative, deflation will not be a problem in Canada.”

Canada has reached a “sweet spot” with few worries of either high inflation or deflation, suggested Meny Grauman, a CIBC World Markets economist.
Friday’s report showed core prices, excluding volatile items such as energy and fresh vegetables, holding at the Bank of Canada’s target of two per cent.
Given the weak economy and low inflation, a C.D. Howe Institute panel of economists is recommending that the Bank of Canada cut its overnight rate – already at a record low – by a quarter percentage point on Tuesday to 0.25 per cent.

The think-tank said a strong majority in its 10-economist survey favoured so-called quantitative easing – the central bank adding to the money supply by buying assets from the commercial banks – in order to put “additional cash in the hands of private financial institutions to promote further growth in the monetary base.”
Carney will unveil options for quantitative and credit easing on Thursday.

The Statistics Canada report shows food is now the main driver of inflation, up 7.9 per cent from a year earlier, the steepest increase in over 22 years.
This escalation included some startling numbers: potatoes popping 54.9 per cent, fresh vegetables 26.5 per cent, fresh fruit 19.3 per cent, non-alcoholic beverages 10.2 per cent, cereal products 11 per cent and meat 7.6 per cent dearer than a year earlier.

Shelter costs rose 2.1 per cent last month, a slower rate of increase than in February.

The most important factor pushing the inflation rate lower remains gasoline prices, which were slightly higher in March than in February but were 21 per cent lower than a year ago.

Excluding gasoline, inflation would have been double at 2.4 per cent in March, the agency said.
Prices for other fuels fell 32.9 per cent, and transportation costs were down 6.2 per cent in March. The cost of purchasing or leasing a passenger vehicle dropped 7.4 per cent.

On a month-to-month basis, consumer prices edged up a modest 0.2 per cent, after rising 0.7 per cent in February.
The agency said the inflation rate slowed in all provinces except the two most populous, rising to 1.8 per cent in Ontario from 1.5 per cent the previous month, and holding steady at 0.8 per cent in Quebec.

Here’s what happened in the provinces and territories. (Previous month in brackets):

-Newfoundland and Labrador 0.5 (0.9)
-Prince Edward Island -0.2 (1.0)
-Nova Scotia 0.0 (0.4)
-New Brunswick 0.2 (0.3)
-Quebec 0.8 (0.8)
-Ontario 1.8 (1.5)
-Manitoba 1.1 (1.7)
-Saskatchewan 1.8 (2.6)
-Alberta 0.9 (2.1)
-British Columbia 1.1 (1.5)
-Whitehorse, Yukon 2.3 (3.3)
-Yellowknife, N.W.T. 0.9 (2.0)
-Iqaluit, Nunavut 3.9 (3.1)

The agency also released rates for major cities, but cautioned that figures may fluctuate widely because they are based on small statistical samples (Previous month in brackets):

-St. John’s, N.L., 1.1 (1.3)
-Charlottetown-Summerside, 0.2 (1.2)
-Halifax, 0.2 (0.2)
-Saint John, N.B., 0.3 (0.4)
-Quebec, 1.0 (0.8)
-Montreal 1.1 (1.0)
-Ottawa 2.1 (1.8)
-Toronto 2.1 (1.7)
-Thunder Bay, Ont., 1.9 (1.9)
-Winnipeg, 1.1 (1.7)
-Regina 2.6 (3.3)
-Saskatoon 1.6 (2.4)
-Edmonton 1.2 (2.4)
-Calgary 1.1 (2.4)
-Vancouver 1.3 (1.6)
-Victoria 1.1 (1.5)

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There are presently 3 mortgage insurers in Canada: CMHC (Canada Mortgage and Housing Corporation), Genworth, and AIG. Many lenders have stopped using AIG and Genworth in the past few months as they do not have 100% guarantees to the lenders in the event of loss on a mortgage. However, the private mortgages insurers: Genworth and AIG have really driven the entire industry in terms of what debt service ratios, credit standards, and property standards are acceptable in order for banks to offer fully discounted rates.

With AIG on the ropes (in my opinion) and being offered by only a handful of lenders, Genworth recently changed their guidelines to reflect a more conservative stance on mortgage financing in Canada.

Effective April 18th, 2008 Genworth will have the following guidelines:

The changes will affect new borrowers with less than 20% equity/down-payment.

Among other things, Genworth is reportedly:
• Discontinuing its high-ratio rental and Credit Assist programs.

• Lowering its maximum TDS guideline from 44% to 42% for all products

• Increasing credit score requirements for its Cash-Out Refinance program, from:
o 650 to 700 (for 90.01-95% LTV applications)
o 600 to 660 (for 85.01-90% LTV applications)

• Imposing new credit score minimums for high-rise (4+ floors) condominiums of:
o 700 (for 90.01-95% LTV applications)
o 660 (for 85.01-90% LTV applications)
Genworth did not previously have credit score minimums specific to high-rise condos.

• Increasing credit score requirements for its Business For Self (Alt. A) product, from:
o 650 to 700 (for 85.01%-90% LTV applications)
o 650 to 680 (for 80.01%-85% LTV applications)
o Genworth is eliminating LTV’s over 90% (previously it allowed BFS applicants to borrow up to 95% LTV)

Genworth said it will accept applications for the above programs (under the old guidelines) until April 17.
Collectively, these are significant changes for Genworth. The rationale for the changes has not been freely spoken-of by Genworth at this time. However, if CMHC keeps it’s own guidelines as-is, Genworth will likely lose additional market share to the country’s number one insurer (CMHC). This has been a trend in effect for the past year and a half, regardless.

So, the market tightens further. Will prices continue downwards, despite more market activity? It’s anyone’s guess at this point.

There was an article published by Bloomberg on April 14th whereby the author, Sean B. Pasternak, made the point that rates are very likely at the bottom of their cycle. With many of my clients wanting a variable rate mortgage to “take advantage of the low interest rates for the next couple years,” I felt it prudent to take a step back and look at this market and rate environment in terms of historical comparison, for I don’t believe we are going to see two years of rates at this level.

In physics, when laser is pointed down towards a mirror at 30 degrees, the resulting reflection bounces back at the same angle: 30 degrees. In markets, especially financial markets this is often (but not always) the case with trends. The rapid decrease in rates in the past year is likely, but not guaranteed, to result in an equally rapid rise when the market comes out of recession. Rates have fallen from a high of around 5.90% a year ago to around 3.85% today. That is a change of 2.05% or a drop in around 35% in interest rates.

To put that in comparison, the same house with a mortgage of the same amount, (say, $500,000) would have had a payment of $2,810 last year, but can now be had with payments of only $2,160. That is a drop in the amount of $650 per month for no reason other than the economic conditions in the interest rate market.

In other words, affordability is back, but is it here to stay?

Back to my comparison to physics: the things will rebound on the same angle or trajectory as they initially arrived. With that logic, we may see a rapid increase in rates in the future as there are already signs of an economic turn around just barely underway.

My point? Taking a variable rate at Prime + 0.80% (the average market rate) results in a 5 year variable rate of 3.30% versus a fixed rate of 3.85%. This is a difference of 0.55% and most borrowers look at this number and get excited that they will be saving money. However, the last interest rate drop of 0.50% happened very fast, and could go in the opposite direction equally as fast. In fact, if inflation rears its head, we could see a move of more that 50 basis points (0.50%) occur rapidly wiping out all the savings of a variable rate mortgage, but none of the inherent risk.

Prime rate at the banks follows the Bank of Canada’s lending rate to the banks. With the benchmark rate set at 0.50% how much further can variable rates descent? I would suggest that they can’t, and that taking a variable rate in these times is akin to buying Nortel at the peak and hoping that it could go higher still. It isn’t likely.

With that in mind, why take the risk on a variable rate, hoping and praying that rates will fall, when fixed rates are at their historic lows? I have put my money where my mouth is and locked my own mortgages into fixed rates as I think these are rare times that are soon to disappear.

Some food for thought….

The article, published in its entirety is below:

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Mortgage rates in Canada, which have plunged by almost 50 percent in the last year, aren’t likely to fall further, said Phil Soper, chief executive officer of Brookfield Real Estate Services Fund.

“Certainly with the Bank of Canada’s target rate set at virtually zero, there’s very little room,” Soper said today at a conference in Toronto on Canada’s real estate market. The rate is “the lowest it’s been in anyone in this room’s lifetime.”

Rates for home loans have been dropping during the biggest financial crisis since the Great Depression, with some lenders offering mortgages approaching 4 percent, Soper said. That compares with an average posted five-year rate of 7.5 percent a year ago, according to the Bank of Canada. He added that home prices in Canada aren’t likely to rise “sharply” over the next two years.

Bank of Montreal, which sponsored the conference, lowered its rate for a five-year fixed-rate mortgage this month to 4.15 percent.

“We are approaching almost zero interest rates,” at the Bank of Canada, said John Turner, the Toronto-based bank’s director of mortgages. “The question becomes, how much upward pressure will there be as we come out of this recession?”

The Bank of Canada last month cut its benchmark lending rate to 0.5 percent, its lowest ever, and said it’s preparing to use policies beyond interest rate moves to revive an economy hit by a recession and tight credit markets. The next rate announcement is April 21.

Canadian existing home sales rose in February for the first time since September as buyers took advantage of lower mortgage rates and prices, according to the Canadian Real Estate Association’s Multiple Listing Service. Sales of existing homes rose 8.6 percent from January to 28,669 units.

Bank of Montreal senior economist Sal Guatieri predicted that Canada’s housing market will decline further this year, without the “crash” experienced in the U.S.

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