Most of the public is unaware that no down payment or zero down mortgages still exist. On October 15, 2008 the rules passed by Canada’s finance minister took effect, and the existing no money down program was canceled. However, only that one program was canceled.

There IS another way…

There are a few banks that will “give” you 5% of the purchase price allowing you to get 95% financing. This program is called “flex down” and here is how it works:

1. You pay posted rates instead of discounted

2. The cash is given to you at closing allowing you to put it as the 5% down payment

3. You need to show cash assets of 1.5% of the purchase price of the home to prove you can afford to close on the transaction

4. Still need a deposit!

5. You pay higher CMHC fees

POSTED RATES:

In mortgages, as in all other elements of business there is no such thing as a free lunch. The 5 year posted rate is 5.49% as of today, with discounted rates in the 3.89% range. You will need to pay the higher 5.49% rate. This way, the bank recoups it’s 5% gift of money that it gave to you over the 5 year term. And yes, you MUST take a 5 year fixed term. It doesn’t matter if you only want a 3 year, or a variable rate, you MUST take a 5 year fixed term at posted rates. In this way, the bank is getting the 5% back from you spread out over the 5 years.

Think of it as forced savings of the 5%, but you get to live in the home while you save!
CASH GIVEN AT CLOSING

The 5% cash gets sent to the lawyer’s office handling the transaction. Then, the mortgage money shows up for the other 95% and the house is yours!
NEED TO SHOW 1.5% CASH ASSETS

The bank needs to know that if they give you the 5% that you can still put up some money to cover property transfer tax (if applicable), move in costs, utility transfers, etc… WITHOUT borrowing the money. You’ll need to show 1.5% of the purchase price of the home in an account in your name. How it got there isn’t an issue. It just has to be in your account.
STILL NEED A DEPOSIT

When you write an offer, you will still need to have money to give as a deposit. This is generally considered “good faith money” as it is non-refundable. Typically, it is customary for the deposit to be 5% of the purchase price. However, this is just CUSTOMARY. You need to tell your realtor that you need the deposit loan as low as possible ($1,000 or $5,000) and you need to be able to write this cheque! You can get it on a visa cash advance, borrow it from friends or family, or what have you.

Remember, you will get it back at the closing date when the bank’s 5% shows up but you still need it in the interim and this is an often forgotten element to no money down purchases.
HIGHER CMHC FEES

Whenever you put less than 20% down on a purchase you face CMHC fees. They are government mandated fees, and you can find out more about them and what they are by doing a search on my blog for “CMHC fees” as I’ve written several articles explaining them.

When you do a “flex down” purchase or no money down, the CMHC fees are 2.90% base instead of 2.75% base and they are BUILT INTO THE MORTGAGE – meaning you don’t have to write a cheque for them up front.

THAT’S IT!

I’m working on two of these deals for clients as I type this blog entry, and both are getting approved. So, if someone says zero down or no money down mortgage isn’t available, give them my contact info and I’ll get them set up!

Thanks again, and happy house hunting!

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.

You read that right…

The biggest of the banks are all writing down investments and claiming huge losses. In fact, in the case of some institutions, they have had to go back to the equity markets to raise capital.

TD Bank said it was forced to raise up to $1.4 Billion in new capital to shore up their reserves. This is a very large step (selling a stake in itself) and has made it one of the few institutions in the world to issue common equity given the state of the markets.

RBC said they too would be raising $225 Million, a far more modest amount, by selling recallable preferred shares on the heels of disclosing over $1 Billion in losses on its investments that have depleted its reserves.

Scotiabank also announced that they would be taking a $595 Million dollar after-tax loss due to the turmoil in the financial markets. The charges include $115 Million in trading revenues related to the Lehman Brothers bankruptcy, and $370 million in adjustments to the value of their investments.

So, the big banks are taking losses all over the place. The market is changing, and the mortgage offerings that people will receive will no doubt change as well to account for this. I will be posting a lengthy post tomorrow about how the Canada and US markets differ, and I hope this makes the case that even price-heavy markets such as Vancouver do not have to worry as much as the US.

Looking back at the past, oh, 15 years that i’ve been consciously aware of the banks, finances, and the market, I cannot remember seeing the banks take these steps: even during the massive losses that were incurred in the tech bubble. Change is in the wind and I have no idea where it will take us, but I’m sure that wherever it is, money will remain tight for a very long time.

The bank of canada moved rates more than expected today by lowering its target overnight rate by 0.75% to 1.50%. Usually, this means the banks will follow suit by lowering their prime rate by 0.75%

USUALLY…

Does this mean the banks “have to lower prime rate” by 0.75%.

NO.

There is no legal mechanism that preserves this relationship. The Bank of Canada is not able to force the banks to lower their rates as doing so would be tantamount to forcing the banks to potentially take a loss. Highly unlikely.

The inital reaction was the TD, RBC, Scotia, and several other lenders lowered their prime rate. But, by how much? In EVERY case so far, prime rate at the banks has only fallen 0.50%.

The exact same thing happened the last time the Bank of Canada lowered its prime rate: initially the banks didn’t follow suit. However, competitive pressures (not the Bank of Canada) resulted in them ultimatley all lowering rates to same level as the Bank of Canada.

With the recent declines in trade, real income growth, and consumer confidence, the Bank of Canada no doubt hopes that this move will spur some further consumer spending. With sales this year already higher than last year at retailers (so far) , the lower rates paid by consumers may be working, but lower rates usually take several months to filter down to higher spending, so likely we are seeing the results of prior rate cuts.

With lower rates available in Canada, look for the Canadian dollar to tread lower in coming days. Why? Rates have been falling on fixed rate mortgages (and term deposits) for a few months now. As rates available to investors go lower, the demand for Canadian dollars falls, and therefore, the price falls. The relationship is more complex than this, but this provides a macro look at why we may see a lower dollar in the future.

The Bank of Canada will continue to monitor the economic conditions and will make another planned announcement on January 20th, 2009 when they next meet.

So, I am happy to see rates falling, as this always makes my job as a Mortgage Broker easier and easier. That said, there is a reason that the banks have eliminated discounts off of prime rate in past months: lower profits (or sometimes losses). Most institutions are still at prime + 1% for variable rate mortgages (with a couple at Prime + 0.60%). With the rates falling lower, and therefore their profits, how low can the banks allow the variabler rate mortgage to go?

My asnwer is that clients that have a discounted variable product (whether it is at prime – 0.90% or prime – 0.35%) you should hold tight and NOT convert to fixed until we see an upward bias appear in rates. Currently, rates appear to be poised to fall further. For clients looking at variable rates on a NEW mortgage, you may want to take advantage of some of the low 4.80% fixed 5 year rates that are available. However, you personal situation may make the prime + 0.60% variable an attractive offer. Call me for a free consultation and to determine what is in your best interests at 604-657-6775 as I am a registered mortgage broker and AMP (Accredited Mortgage Professional).

I was listening to the president of CAAMP (Canadian Association of Accredited Mortgage Professionals) today and he was making mention of his take on interest rates, where they are, and where they are going. I thought his comments were quite insightful, while also providing some good advice to callers. However, several points were, again, glossed over, and I think we need to cover them here.

WHERE ARE RATES TODAY:

Here is a list of the BEST rates that I am currently offering:

1 Year                – 4.35%
2 Year                – 5.10%
3 Year                – 4.79%
4 Year                – 4.89%
5 Year                – 4.80%
7 Year                – 6.05%
10 Year              – 6.20%
Variable:
5 Year Closed    – Prime + 0.60% (4.60% Currently)
5 Year OPEN      – Prime + 1.00% (5.00% Currently)
Line of Credit     – Prime + 1.00% (5.00% Currently)
Prime                  – Is Currently 4.00%

Since posting these rates I have taken a plethora of question and emails and I will attempt to address them here…

I have received several emails saying, “Rowan, my bank is offering me an open mortgage at PRIME RATE,” and you are posting prime + 1% on an open. How come?”

The answer: If you are an existing client of a bank (RBC for example) and are trying to renew early, and not take any new money, and keeping the same amortization they MAY offer you this deal as it requires no re-registration with a lawyer (it’s already registered at that rate). I say “may” because I have yet to see one of these offers in writing. For a new client, buying a home, or seeking to refinance, this offer is not being extended.

I also hear the question, “Rowan, why is your 5 year rate so much lower than my bank?”

The answer: My firm chooses to do a lot of business with the top lenders in the country. As we send them hundreds of millions of dollars per year, we get treatment that a single client may not receive. Think of it as financial clout or “mass quantity discounts.” Just the same way that you can buy 1 orange for $0.25 or 100 oranges for $20.00 (just an example). The more business we do with specific lenders, the more efficient we are, and the more they like doing business with us – thus they offer better pricing (rates) than they offer – sometimes better than they even offer through their own branches. The bottom line: it pays to use a broker that is associated with a high volume office.

Another common question is: “Yeah, I know your rates are low, but are they with a reputable bank?”

The answer: Of course! They are with a nationally chartered bank! We don’t deal with unstable, unscrupulous institutions. We deal with all the major lenders out there (and some smaller ones you may or not know) but they are chartered banks that are offering my low rates currently.

Lastly, I hear the question from other BROKERS: “Where are you getting that rate?”

The answer: Unfortunately, I am not willing to divulge this information to other brokers. I have worked hard, and so have the team in my office, to establish our relationships with our lenders. This is what makes us different, better, and a cut above the competition: our relationships. If a client wants to discuss who the lender is, that is fine, but I will not give the “keys to the kingdom” to another broker who is unwilling to do their homework. Sorry. This is the same reason I don’t post which lender has which rate on my website or blog. If you like what you see, please give me a call.

Happy hunting!

A realtor friend of mine gave me an article she read recently on the Vancouver Real Estate market by Jim Rohn. I have no idea where it was published, but it was his, and it is VERY good and accurate describing how Vancouver’s Real Estate Market is a “Buyer’s Market” yet no one is buying. I wanted to reproduce part of it here for your reading pleasure:

A Buyer’s’ Market should be just that – a buyers’ market. It’s not a fence sitting, waiting , loitering, delaying, dawdling, postponing, vacillating, hesitating, wavering, faltering, pausing, foot-shuffling market. It’s a buyers’ market. By its very name it means buyers should be doing one thing and one thing only – buying. So where are the buyers and why aren’t they buying?

The irony of a buyers’ market is that even though the opportunity to buy is high, buyer urgency tends to hit an all-time low. The media becomes excited purveryor of negative news and uninformed advice, and buyers buy it all. Actually, it feels like the only thing they’re buying. Their reluctance is ironic since not so long ago buyers were incredibly excited about buying – and it was a sellers’ market. Prices were escalating and it was perhaps one of the most difficult times to buy value and yet people were buying like there was no tomorrow. Buyers were afraid of losing out by not buying even though the advantage was all to the seller. Now a shift has occured and it’s a true buyers’ market and what happens? Fear is in the driver’s seat but the tables are turned – the fear of paying too much seems to stop most in their tracks and immobilizes them.

I found that this was an EXACT description of the Vancouver Real Estate Market. Buyers are ready, willing, and able to buy, but are so concerned about “getting a deal” that they are ignoring the fact they are sitting on the sidelines in one of the best buying opportunities in the last 8 years. I am seeing East Vancouver homes, with basement suite income of $750 per month, selling below $500,000. Instead of looking at the low carrying costs of real estate versus the high income potential, people are treating their home like it is an investment.

YOUR HOME IS NOT AN INVESTMENT!

By it’s very definition, an investment is something that generates returns or profits and that is it. If you rented a home instead of purchased, you would be throwing money away every month. It would be better to buy a home, and ride it out for the long term despite price fluctuations as, at the very least, you would be paying down the principle and would eventually own something. Those people sitting on the sidelines are building no equity at all.

Many people are acting like their financing options will be the same in 6 months, with lower prices. The truth is that financing DRIVES prices, and if the prices are lower, it is because the financing isn’t there (or is there, but is more expensive – thus making the purchase less attractive). A person who purchased a home 6 months ago with a variable rate mortgage of prime – 0.75% for $500,000 and financed 100% of it would face a payment of $2,078 per month (including all fees). However, that some home, today, would require a down payment of 5% ($25,000 cash up front) and would now have payments in the amount of $2,426 per month for the SAME HOUSE. Nothing about the home is better.

“But prices have fallen 10%!” some smarty pants may cry. Ok, so the house is $450,000. With 5% down that is still $22,500 cash out of pocket as a down payment, and payments will still be $2,184 per month! So, you’d have to find a way to save $22,500 AND pay $106 more per month for a house worth $50,000 LESS!!

Are you better off waiting and buying when prices are falling and the financing market is tighetening up? I don’t think so. There are EXTREME cases of prices falling in markets that are far, far and away ahead of them selves (Las Vegas, Nevada comes to mind…) but Vancouver isn’t one of them. With upstairs rent easily $1,500 and downstairs rend easily $750 per month. That still more than covers your entire mortgage payments. Not surprisingly, if you bought then OR now, the rent essentially covers the mortgage and not much more. That is the sign that prices are in line with cost and value – in my opinion.

I have had many clients bail out of this market in the past month claiming they will wait until spring to see if the market is better. Meanwhile, they are paying $1,500 a month in rent, for 6 months ($9,000) and the payments on the same home they wanted to buy before will likely be HIGHER.

Pay attention to this point: the sticker price isn’t what you need to be worried about – it’s the payment. Payments on homes have risen, so of course the prices will fall. So if payments continue to rise with global instability, does that mean prices will continue to fall? Yes! Of course it does. Does it mean you shouldn’t buy? If you are buyinga home, you should still buy and start paying it off. Vancouver has value that cannot be ignored. If you are a buyer and flipper, then I would stand out of this market as quick returns will likely be unavaiable for a very, very long time.

So there is my opinion. Happy shopping!

There is a lot of talk amongs real estate “investors” and specialists saying that the key to buying real estate at low prices is to find foreclosures, pre-foreclosures, court ordered sales, and other distressed sales.

IS THIS A VIABLE METHOD OF INVESTING IN REAL ESTATE?

This is not an easy answer. The quick answer is NO. Otherwise, everyone would be doing it. The longer answer is “it depends who you know.”

Let’s address a few of the terms that are being tossed around, and see how they apply to the Canadian market.

FORECLOSURE

This is the process whereby a lender takes the property away from an owner if they miss too many payments. Usually, the process is about 6 months long starting with an “Order Nisi” into court and ending with an “Order Absolute” when the property is taken away from the borrower and given to the lender. Usually, it doesn’t get this far, and a “Order for Sale” is given and the lender will usually sell the place (possibly by also taking possession and kicking the people out of the home).

PRE-FORECLOSURE

This is a very misleading term that a lot of experts are telling clients to search out. Clients are being told to see out pre-foreclosure by looking for signs of “distressed sales,” or other terms that describe highly motivated buyers. Pre foreclosures are very, very hard to find without having an “in” in the industry. As a mortgage broker, often dealing with a lot of distressed sales, I cannot tell people about my clients in situations that they are being told to seek out. In other words, any broker telling you about specific foreclosures is often violating the confidentiality of their clients. There ARE cases, where the clients are OK with this (for example, when they want to sell desperately), but in most cases those people being foreclosed on don’t want to sell. They want to keep their home just like anyone else.

So where do you find pre-foreclosures? There are often several lawyers in town that deal with foreclosures, and they MAY be willing to provide you with names and addresses of properties that are nearing foreclosure. Alternatively, a broker (me for example) who deals with a lot of hard financing and hard situations may have some clients that are seeking to get out of the property. With proper written permission, I, or other brokers like me who deal with a lot of difficult financing situations, can provide you with people who are highly motivated sellers. However, dont’ expect this information to be widely available for the public at large. You are going to have to work for it, and it won’t be easy. If it was, EVERYONE WOULD BE DOING IT!

The last way to find pre-foreclosures is to look at what is being heard “in chambers” in the local provincial courts. For example, if you go down to the courts you can see what is being heard that day, and if you see “Royal Bank of Canada vs. John Michaels” (for example) you can be relatively sure it is because the bank is starting an action against Mr. Michaels, and it is usually due to a possible foreclosure beginning. This info is also available online on the provincial court websites (depending on what province you are in). However, it will NOT say “Foreclosure Hearings” conveniently labelled. It will take a bit of deduction and work to figure it out because you are trying to get very private info. Again, if it was easy, EVERYONE WOULD BE DOING IT!

COURT ORDERED SALE

Oftentimes, when there is a first and second mortgage holder, the clients may fall behind on payments to the first mortgage holder (often the larger of the two) and have problems making their payments. This will put the second mortgage holder at a disadvantage, because if the first mortgage holder gets an “Order Absolute” it will wipe out the second mortgage holder’s claim. This usually takes at least 6 months, and is a huge song and a dance from a legal perspective, so it tends to result in interest piling up and further equity being eroded. Now, this is a simplification of the process, but if the second mortgage holder sees their equity being eroded with interest (or a falling market) they can apply to the court for Conduct of Sale granting them the rights to sell the property for a fair price to pay out the first mortgage, and themselves, and ensure they don’t lose money on the deal. In order to be granted this, they usually have to demonstrate that their equity is in jeopardy by way of appraisals or other market valuation techniques accepted by the courts. In a falling market, with interest piling up, they will usually be granted an order for sale unless a massive amount of equity exists.

So, when reading and hearing about “Court Ordered Sales” you are hearing about highly motivated sellers. However, don’t expect to waltze in and pay pennies on the dollar. The court still overseas the sale price, and makes sure that the price that is received is fair market value. For this reason, just the fact that someting is a court ordered sale doesn’t automatically make it a “deal.” You still have to do your homework and find a motivated seller through the methods I list in the section above regarding pre-foreclosures.

SUMMARY

The process of seeking our foreclosure and “pre-foreclosures” is not a cut and dry issue whereby you can simply find someone willing to give you a “list.” It takes effort, ingenuity, or industry contacts to track them down, and even then, they might not be a great deal. You still need to look at the direction of the market, the cost of the property, and whether or not it is highly marketable in order to discover how good the purchase really is.

Remember, if it was super easy, EVERYONE WOULD BE DOING IT!

The Bank of Canada anounced today that they are reducing their key lending rate from 2.50% to 2.25% which is a 0.25% reduction in line with market expectations. However, many people were calling for a large decrease equal to 0.50% (also referred to as 50 basis points). So the big question on everyone’s mind is:

Will the major banks follow the Bank of Canada and lower their prime rate?

This is a very tough thing to comment on, but I will give you my gut feelings on this. Let’s first look at the comment released by TD Canada Trust at about 10am this morning:

“There has not been any update at this point if TD will reduce their prime rate further to reflect this latest decrease.”

Talk about sitting on the fence wondering what the other banks will do! The reality is that the cost that banks face to raise money has been rising dramatically, and if they reduce their prime rate it cuts directly into their profits. In the cases of some banks, who are already losing money on variable rate mortgages, this further cut simply cuts deeper into their already bleak profit margins.

I am going to reproduce for you, the comments from the Bank of Canada that came out with the announcement:

“In the face of diminished inflationary pressures, the Bank of Canada lowered its policy interest rate by 50 basis points on 8 October, acting in concert with other major central banks. This extraordinary move, combined with today’s announcement, brings the cumulative reduction in our target for the overnight rate to 75 basis points since the Bank’s last fixed announcement date. These actions provide timely and significant support to the Canadian economy. The cumulative reduction in the Bank’s policy rate since last December is now 225 basis points.

In line with the new outlook, some further monetary stimulus will likely be required to achieve the 2 per cent inflation target over the medium term. The evolution of the financial crisis, its impact on the global economy and the timing of the effects of the various extraordinary measures being taken to address it pose significant risks to the projection on both the upside and the downside.”

So, in light of these comments, I think we can safely say that further rate cuts are in store for us. However, this brings us to the next very difficult question:

Will the rate reduction filter down to the mortgage market?

Historically, and in my experience, moves in prime rate have very little to do with FIXED rates. Oftentimes, there is a couple week lag between the time prime rate comes down to the time that fixed rates also go down… IF they go down. They don’t always go down because fixed rates are not pegged to prime rate. However, when prime goes down, a lot of other rates also go down (for example, bond rates), and this usually drags fixed rates with them.

Variable mortgages are a different monster altogether. While prime rate has been falling, the banks have been changing the discount to NEW variable rate mortgage holders. For example, 6 months ago I was doing prime – 0.75% mortgages (would place you at 3.5% today!!!) but now the lenders are prime + 1.5% which puts you at 5.50% (not surprisingly, nearly the EXACT same as the fixed 5 year rate).

So while the prime rate has been falling, and offering savings to people with EXISTING variable rate mortgages, any new variable rate mortgage applicants will face a higher rate.

So what is the net effect?

With variable rate savings no longer available to new home owners, I suspect we are going to continue seeing more and more price rollbacks as the affordability is being reduced by the banks changing the discounts on variable rate mortgages to Prime + 1.5%

Let me give you a concrete example to see how this will be very costly to a home buyer in Vancouver.

If a person bought a $600,000 home (well below the Vancouver average, by the way) and put $120,000 down, this would leave them with a mortgage of $480,000. Assume prime rate is 4.25%.

If the got a prime – 0.75% mortgage 6 months ago (and they will get the same discount for 5 years) their payments on a 35 year mortgage would be $1,977 per month.

If they got the home today, and had to take a prime + 1.5% variable, they will face a payment of $2,636 per month.

LOOK AT THAT! Why isn’t the media reporting on this!!!

The same house, purchased for the same price, in the same market, BUT with current rates costs $659 more per month today!!!

I’m going to close this entry today with the following comment:

When the average family cannot buy the average home, there is trouble ahead.

This is a very common question, and one that I have addressed before, but have taken three calls from all around North America this week.

Usually the question runs like this: “I would like a fixed mortgage, but I want it to be open. What is your best rate?”

This is a confusion of two common terms. Let me first address the different types of mortgages. For simplicity sake, there are four common types of mortgages, that all combine with one another. They are:

1. Fixed Mortgage
2. Variable Mortgage
3. Open Mortgage
4. Closed Mortgage

Let’s address each in turn. NOTE: these terms are being described as they relate to the CANADIAN mortgage market, not the US:

FIXED MORTGAGES:

A fixed mortgage is one where the rate is fixed for the entire term of the mortgage. For example, if you have a 35 year amortization (pay it off over 35 years) but a 5 year term, that means that you will have a fixed rate for 5 years, with a fixed payment for 5 years, and a fixed rate for 5 years. The mortgage rate and payment are FIXED for the term. Terms vary from 1 to 10 years (a couple lenders do longer) and the average term people choose is 5 years (which is also the length of time over which the banks compete most aggressively).

VARIABLE MORTGAGES:

A variable mortgage is one where the rate varies with some other rate. The most common rate that the mortgage moves with is the “Prime Rate.” Traditionally, the Band of Canada (BOC) sets their prime rate, and the banks then follow and set theirs at the same rate. The prime rate is the rate that preferred borrowers with clean credit and good income can receive. There is no law that says that the banks must follow what the BOC does, and in the current market in Sept / Oct 2008 the banks have chosen on a couple of occasions to NOT follow the BOC right away or to follow them precisely. A variable rate mortgage usually results in a payment that also varies with prime rate (often making budgeting difficult), and a rate that varies according to the market. While most variable rate mortgages are convertible into a fixed rate at any point in time, the rate you can convert at is “usually” quite high relative to what you would get on the open market.

OPEN MORTGAGES

An Open Mortgage is a mortgage that has no pre-payment penalty. With most mortgages in Canada, if you pay out the mortgage before the end of the term, you will pay an interest penalty (usually equal to 3 months interest payments but there are alternative penalty calculation methods). Open mortgages do not face the interest pre-payment penalties that other mortgages face.

CLOSED MORTGAGES

With a Closed Mortgage, you WILL face an interest penalty to pay it out prior to the end of the term. For example, if you have a 5 year term, and you pay off the mortgage in 2 years (whether it is due to a sale of the home, lump sum of cash, or any other manner) you will face an interest penalty usually equal to 3 months of interest. There are other methods of determining pre-payment penalties, but the 3 month interest is the most common unless rates have fallen dramatically during the term of the mortgage.

So why would anyone take a closed mortgage? Answer: Because they (typically) have far, far better rates when you commit to a set term. Also, that is the industry standard in Canada.

So, based on the info above, you can combine the terms (no more than 2 per combination) to get a feel for what is available in the Canadian market place.

You could have:

Fixed Closed Mortgage
Fixed Open Mortgage
Variable Closed Mortgage
Variable Open Mortgage

You may wonder, “Why doesn’t EVERYONE get a fixed OPEN mortgage?” As that seems like the best combination of security (fixed rate) and no penalty (open). The answer is: the rates are far higher. If the banks are going to go through all the effort and time to do a mortgage for you, and commit the money, they want to know they are going to get that stream of income for the length of the term. When you purchase a term deposit fromt he same bank for, say, 2 years, you expect to get 2 years interest, not get 1 year and have the bank cancel after 12 months because they can pay less to someone else! What’s fair is fair. If you commit to a term, expect a penalty.

Often people say to me, “yes, but what rates are available for each product?” I’ll show you my best rates currently for each product below:

5.35% – Fixed Closed Mortgage (based on a 5 year term)
8.10% – Fixed Open Mortgage
5.25% – Variable Closed Mortgage (Based on Prime rate plus 1%)
5.25% – Variable Open Mortgage (Based on Prime rate plus 1%)

Clearly, taking a Fixed Open Mortgage is the best in terms of flexibility, but the rate is far higher and thus payments of a huge obstacle. Also, the difference between a fixed and variable rate is not much. In fact, you can get a 0.10% lower rate by taking a variable rate! This might sound like a good deal, but how much is your peace of mind worth? If rates shoot up by 1% due to an economic crisis, your payment will jump substantially (by 1%) and this will result in a much much higher payment.

How much higher?

Assuming a $300,000 mortgage, the savings of taking a variable rate mortgage (0.10% savings) will result in a savings of $22.14 per month. Assuming rates stay steady for ALL FIVE YEARS you will save $1,328.40 by taking a variable rate mortgage. Not bad, right?

Wrong. If you assume that prime rate moves up by 1% due to a shocking economic crisis (much like we are facing now) your payment would jump from $22.14 lower to $203.85 HIGHER simply due to factors beyond your control. This, by the way, assuming it happens 2 years into the mortgage, will result in 3 years of higher payments equaling $7,338,60 more. So you would be out by THOUSANDS of dollars just for trying to save $22.14 a month.

My advice: In this market, take a fixed rate. Enjoy the fixed payments, and sleep easy at night knowing your payment will be the same this month as it will next month for the entire term.

With respect to Open vs. Closed mortgages, unless you are buying with the intent of flipping it off (and NOT buying another property) ignore this. Take a fixed closed mortgage, and you’ll be glad you did.

If you are considering buying an investment property which you may quickly sell, THEN, and only then, do I recommend an open term.

On September 16th, Stephen Harper made an election announcement of a tax credit of up to $5,000 for First time home buyers which will provide tax savings of up to $750. The announcement was welcomed warmly by the Canadiam Home Buyers Association (CHBA).

CHBA President, John Hrynkow said, “This is a practical measure that will help many first-time buyers as they struggle to realize their dream of owning a home.”

This annoucement provides a subtle clue to the stance of the Conservatives as to the importance of home ownership to Canadians as well as the impact that the New Housing industry has on the national economy and overall well being. The New Housing market has been one of the key reasons, speculate economists, that Canada has fared well in the slowing economy as the New Housing industry has remained strong.

Mr. Harper indicated that if elected (and as of the writing of this article he has been re-elected) the Conservative government will phase in a tax credit over four years for up to $5,000 of the closing costs on the purchase of a new home. According to Mr. Harper, this will result in tax savings of $750 for first-time home buyers.

My opinion on this announcement is, “In this market? (Vancouver) Who cares?”

This $750, or even $5,000 is a drop in the bucket in terms of home ownership in Vancouver. Also, the only mention in the announcement is that this will be a tax savings of UP TO $750 for those first time home buyers who buy a “New Home,” not just “their first home.” So, it seems to imply that if a first time homebuyer is buying their first home, and it is NOT a brand new home, then they may not receive the tax credit. While I am not sure about precise percentages, I suspect that the RE-sale market is far, far larger than the new home market, and furthermore, that most of the people buying brand new homes are NOT first-time home buyers (unless buying a condo – to which it is unclear if this tax credit will apply).

In a market where a 1 bedroom condo is selling for upwards of $400,000 a $750 sounds like it will hardly make a dent. I know the government’s heart is in the right place, and across the country I am sure it adds up, in the aggregate, to a substantial tax savings for everyone. But on an indvidual basis, it doesn’t look all that great. Also, what elements of closing costs constitute a deductibe expense is another thing that isn’t clear.

Regardless, I don’t think it will have much economic impact, although I am pleased to see the government recognizing the importance of home ownership to Canadians.