This is a question that gets tossed around a lot. Several large organizations have come out stating that “the recovery” is already underway, or that the recovery is going to start this quarter or next.

I personally don’t buy it. This article and content is very incendiary to people who always advocate “buy buy buy” so I’m sure people will disagree.

If you want to read the article by Remax that says the market is about to take off, you can do so at:

http://www.canada.com/business/fp/Canadian+housing+market+recovery+mode/1786722/story.html

I attended a conference in Toronto a few weeks ago and listened to Benjamin Tal speak (CIBC Economist). He brought up a concept that several people have been talking about: whether this is a “U-shaped” recovery or a “W-shaped” recovery.

In a U-shaped recovery, there is a crash, a period of pain, and a recovery where the market takes off again and doesn’t look back. In a W-shaped recovery, there is a crash, a false recovery, a deeper crash (where the real pain takes place) and then a recovery. The W-shaped recovery is usually far more prolonged than a U-shaped recovery.

The bottom that everyone thinks came and went needs to be re-evaluated. Let’s look at what has occurred from a financing standpoint and you be the judge of what type of recovery we’ve seen:

In the run up to the crash we had the cancellation of the 40 year mortgage and the zero down mortgage. Almost THE DAY the crash began, was the day that those products ceased to exist in Canada. With the longer amortizations gone, and no more zero down available, affordability and access to housing was restricted. While not everyone used these products, it is naive to say that their disappearance wasn’t a contributing factor to the slowdown. This, all at the same time as the huge Wall Street fallout with the Lehman Brothers going down, and the events we are all now familiar with ensued.

In the period where sales really started to fall (October through March) 5 year fixed rates started at around 5.24% on November 1^st and hit a low of 3.60% on June 1st. Almost on queue, the market “picked up” and sales shot to an extreme high in June of 2009.

During the same period of time, prime rate fell from 4.50% to 2.25%. A fall of FIFTY percent!

Also during the same time, the premium on variable rate fell from prime rate plus 1.50% at many lenders to prime rate plus 0.30% at currently. So, by the time the rate drops had filtered down, you had financing rates that were now on average 50% lower than they had been previously. At the same time as this was going on prices were falling, and falling harder than people who follow “benchmark prices” were letting on. Prices in Vancouver had obviously declined, and declined a lot. Some estimates were 20%, but there is evidence of far greater declines in other municipalities or amongst high end properties or “unique” properties.

So, we have a crash in prices, and a crash in rates. Let’s see how this translates into affordability:

A $400,000 mortgage in a 5 year fixed rate before the crash would have had a monthly payment of $2,066.00

A $400,000 mortgage in a 5 year fixed after the crash (assuming the average 20% decline) would have a payment of $1,337.00.

$2,066
$1,337
$729

That’s a decline of 35%, and what did buyers have to do to make these savings?

Nothing.

They just had to wait and NOT BUY before when rates were higher. I honestly believe, and feel that the evidence shows, financing accessibility and rates, drive prices.

Where are we now?

Junes’s sales were one of the highest on record… EVER. Even higher than the 2006/2007 meteoric rise. 5 year fixed rates have climbed from around 3.65% to 4.39% at most lenders. Economists feel rates are going to continue upwards further yet (although there may be a short term pullback). Also, prices and the frenzied pace of the market have increased dramatically. Bidding wars are back, multiple offers with no subjects or conditions are back, and prices far… far… far over asking price are also back. So the market is heating up, right?

Maybe not…

A lot of those purchases going on right now are for buyers that have pre-approvals at the old lower rates. Those pre-approvals are good, in most instances, until September 30^th. So the real question is not “where are we right now?” but “where will we be at the end of the year?”

The thought scares me, but I too own real estate and I’m not selling. Why? Because I’m holding it for the long term. People holding for the short term, or thinking they are going to upgrade right away, or buy and flip, might be in for a rude, rude surprise.

So there is the evidence I’m putting forth, and why I think there is going to be another downturn before we see long term stability.

Comments? Let me hear them!

Whenever someone wants a loan the bank won’t do, they call me and ask, “but don’t you have any private lenders?”

Of course I do, but they don’t lend on EVERYTHING.

Let me start by saying that the title of “Private Lender” doesn’t mean “Stupid Lender.” In fact, if anything, they are the shrewdest lenders out there, and are very concerned about safety of their capital.

Generally, private lenders will not lend more than 75% – 80% of a property’s value. If the property is just land, then than gets shaved to 50% – 65%. If the property is very odd, hard to sell, or “unique” then you can bet private lenders won’t touch it.

Why? Because private lenders do loans that are higher risk than the banks. Therefore, the chance of someone defaulting are higher. If they have to go through the legal process, it may be months, or years, before they get their capital back. With costs and interest, they can end up losing money, so they simply won’t lend beyond 80%. They won’t.

So where DO they lend?

They lend to people with poor credit or non-verifiable income, but WITH equity. They want to see roughly 20% – 25% (or more) equity in a property when their loan is taken into account.

So, let’s say you have a $400,000 home in Surrey. You have a $200,000 mortgage and $200,000 equity. You’ve fallen on hard times, and need $40,000 to pay off some credit card debt. However, you’ve missed several payments, and your bank won’t lend you the money. This is an IDEAL situation for a private lender. There is lots of equity (more than 25%) and they’ll give you the $40K without messing up your low rate 1st mortgage with the bank.

That is just one example, but you get the idea. They want EQUITY in the property whether that is a down payment, or existing equity. You won’t be getting 85% or 90% financing from a private lender. It’s just too risky for the lender.

Other situations they’ll lend:
1. Poor credit
2. No credit
3. Non-residents
4. Non-verifiable income
5. Non-traditional income
6. No income
7. Raw land
8. Serviced Land
9. Former grow ops
10. Construction situations

Nowhere on that list do you see “no equity” or “no money down.” You MUST have equity, and a healthy margin of it. The old saying from private lenders is that they want to see that the borrower has “some skin in the deal,” so that if things go sideways, the get hurt as much as the lender does.

Situations they will NOT lend:

1. Unsecured
2. Businesses and restaurants where there is no land or real estate component
3. More than 80% financing is required

Ultimately, private lenders are just people with wealth that are concerned about losing it. Just because you’ve heard we brokers have access to private lenders, doesn’t mean we have access to lenders that will give anyone money for any percentage of the property. Ultimately, you’ll need equity.

It’s just the way it is.

As I’ve mentioned countless times on this blog, fixed rates are not tied to variable rates. We all saw fixed rates rise in the past month despite variable rates (prime rate) staying the same. Why? Fixed rates are set based on what banks can get on bonds for similar lengths of time. For example, if the bank can get 3.00% on a fixed 5 year bond, then they will demand 3% + some premium in order to do your mortgage, absorb some risk, and handle inquiries. Therefore, bond yields drive fixed rates.

Here is a graph of bond yields to take note of:

In this image, you will note that bond yields (and fixed rates) had a heck of a run-up, but have pulled back. However, mortgage rates have NOT pulled back. Why?

Some “off the record” discussions with lenders is that no one wants to be the first to drop rates and RE-initiate the rate-war that occurred recently. Also, banks are starting to focus on profit-before-growth instead of just focusing on market share.

Gone are the days of, “buy my friend just go x.xx percent at RBC! Why can’t I get that?” Just like it has in every other facet of finance, your rate will be based on what the risk of your mortgage presents to the various lenders.

Kind of the way it should be, isn’t it?

The question of “fixed or variable” comes up so often I just had to put a post out about it.

There are a number of considerations that need to go into this analysis, and it is different for everyone. The variables I would recommend considering are:

1. How long you are going to be in the home?

2. Is your income fairly stable or does it fluctuate?

3. How tight is your budget using a fixed and variable rate?

4. Will a rising mortgage payment make you lose sleep or stress out?

5. Where are rates headed?

6. Do you follow rates and financial news closely?

HOW LONG ARE YOU GOING TO BE IN THE HOME:

First, most variable rate mortgages are 5 year terms. This means that if you are possibly selling, or refinancing in the 5 year term, then perhaps a shorter term is best. If you are going to be in the home for more than five years, then you can pretty much take whatever form of mortgage best fits your situation based on your answers to the other questions above. As a general rule, if someone is going to be moving in the near future, or thinks that they may want to buy a larger home in the not-too-distant future, then I would take a make a determination partially based on this variable. Sure, if you take a mortgage, any mortgage I offer is “portable” to a new property, but if you need to borrow additional funds, you’d be borrowing them at current rates and taking a “blended” rate based on the rates when you buy/move to a new home.

IS YOUR INCOME FAIRLY STABLE OR DOES IT FLUCTUATE?

If you are on a stable salary, then taking a fixed rate is likely the safest bet as you are going to get a set payment. Taking a variable rate mortgage means your payments could go up (or down) on any given month. If your income is fixed, then this is an argument for a fixed rate. However, the answer to the next question then becomes of paramount importance: how tight is your budget. If your income is variable, or if you are self employed and your income fluctuates wildly, then it seems (to me) to be a recipe for trouble to take a mortgage with a variable payment, and a variable income. If you are really “on top” of your finances, then you can likely make it work. Alternatively, you can use lines of credit or “overdraft protection” to manage your cash flow should there be a particularly lean month. My experience over the last ten years, however, is that in times of rising rates, variable rate mortgages cause a lot of stress and heartache for people who work hourly or suffer from unstable income.

HOW TIGHT IS YOUR BUDGET USING A FIXED AND VARIABLE RATE?

If you look at the payments for a 5 year variable rate (currently 2.65% today) versus a 5 year fixed rate (currently 4.19%) you will, obviously, find the lower variable rate payment attractive. However, if you have to “stretch” or “tighten your belt” or find that the variable rate payment, while possible today, is still high, imagine what would happen if the rates rise? We are at historical lows in rates today. Can you afford it if rates rise by 1% or 2.5% (a VERY common move in interest rates over a 5 year period of time on variable rate mortgages). If you find that you need to take a variable rate to “afford” the payment, then you shouldn’t be taking it. If you can afford to make the same payments as a fixed rate mortgage (just more goes to principal) then you can consider a variable and enjoy the lower rate of interest and higher rate of payment.

WILL A RISING MORTGAGE PAYMENT MAKE YOU LOSE SLEEP OR STRESS OUT?

Some people, and I admit to being one of them, like to know what the monthly cost of living is. I like to know, with certainty, what my monthly bills are going to be so that I budget things out. If my mortgage payment starts to rise (as rates rise) it will stress me out. For this reason, I have chosen peace of mind over interest rate savings. This doesn’t apply to everyone. Some people would rather “let it ride” and take a variable rate as they have historically cost less for borrowers about 95% of the time. However, there is always that 5% when variable rate causes trouble, and the last question we need to ask is possible the most crucial:

WHERE ARE RATES HEADED?

Prime rate (the rate that variable rate mortgages are based) is at the lowest point it has EVER been in Canadian history. These are “emergency rates,” as the Chief Economist for CIBC, Benjamin Tal, has called them. With rates sitting on the floor, there is only really one way for them to go: up. The question is, when will they go up? And how far will they rise? Many people jump to point out that the Bank of Canada has stated they intend to hold rates low until the end of 2010. While this is technically true, there is nothing binding the BOC to do so. If inflation starts to creep up (and it IS creeping up) you can bet that the BOC may change their tune. So, if the difference between 4.19% and 2.65% (fixed versus variable) is 1.54%, by taking a variable you are thinking that prime rate will not rise by 1.54% in the next 5 years, or that if it does, it will stay low long enough for you to reap significant savings.
DO YOU FOLLOW RATES AND FINANCIAL NEWS CLOSELY?

If not, how will you even know when rates rise or fall? For my clients, I keep them all up to date via email with rate updates so they can see the trends for themselves and see what rates are available on conversion. Use your bank, and they don’t care a whit. Use another broker, and I can’t say what their follow up is. Bottom line: if you don’t follow rates frequently, variable poses an added risk as you will only know your rate has risen when your payment is higher (many people fail to even notice that!).

MY PERSONAL TAKE

I think 5 year rates at anything less than 5% is a damn good rate. Period. I prefer fixed rates, but that is just me, and it will differ for everyone. Historically, variable rate mortgages were offered at prime rate or BELOW prime rate. Today it is prime PLUS 0.40% (down recently from prime PLUS 0.80%). This means if you choose variable, you are choosing to lock in that premium for 5 years. If rates start to rise, and banks start to offer prime rate again, you will be still at prime PLUS 0.40% with no hope of getting out.

Lastly, as fixed rates rise independently of variable rates, even though you can convert to a fixed rate at any time, there is no telling what that fixed rate conversion option will give you. Three weeks ago if you were at prime + 0.40% you could swap out to 3.79% at many lenders. Today, it’s around 4.49%. So even with prime rate not moving, the conversion option has trapped a lot of people in variable; hoping that fixed rates will come back down so they can get out – a remote likelihood.

So that’s my take: I prefer fixed rates in this environment with near-record lows. I’ve put my money where my mouth is and locked in my mortgages. However, depending on your answers to the above questions, maybe you think differently and want a variable. Great! I’m happy to help anyone with the process.

Thanks for reading!