Fixed vs Variable Rate Debate
I have received a lot of questions regarding the difference between fixed and variable rates. What are they based on? Do they both move at the same time? Why is it harder to qualify for a variable? All great questions, and all questions that you need to be clear on before signing into a mortgage contract. Fixed mortgage rates follow the pattern of Canada Bond Yields, plus a spread, where bond yields are driven by economic factors such as unemployment, export and inflation. Variable mortgage rates are driven by the same economic factors, except variable rates fluctuate with movements in the prime lending rate, the rate at which banks lend to their most credit-worthy customers. Variable mortgage rates are typically stated as prime plus/minus a percentage discount/premium. For example, a variable rate could be quoted as prime - 0.8%. So, when the prime rate is, say, 5%, you will pay 4.2% (5%-0.8%) interest.The Bank of Canada adjusts the prime rate depending on the state of the economy, as determined by the economic factors introduced above. Together, combinations of unemployment, export, and manufacturing values shape the inflation rate. Generally speaking, when inflation is high, the Bank of Canada will increase the prime rate to make the act of borrowing money more expensive. Conversely, when inflation is low, the Bank of Canada will decrease the prime rate to stimulate the economy and improve the attractiveness of borrowing.In terms of the discount/premium on the prime rate applied to variable rates, mortgage lenders set this based on their desired market share, competition, marketing strategy and general credit market conditions. These are the same factors that drive the spread between lenders' fixed mortgage rates and bond yields.Qualifying for fixed and variable rates has changed over the last couple of years. Before I break down the differences in qualifying, let's talk about the Benchmark rate in Canada. The benchmark rate is a rate that lenders are required to use to qualify mortgage borrowers in Canada who want a variable rate mortgage or a fixed mortgage term of less than 5 years.The purpose of using a qualifying benchmark rate is to ensure that those who qualify for a mortgage in Canada can qualify with breathing room. In the event of a downturn in the economy or increase in rates down the road, this prevents Canadians from becoming orphaned homeowners without a lender willing to assist them. We are in an era of all-time low interest rates, so the sad reality is they have nowhere to go but up. Purchasing a home at a rate of 2.99% looks amazing today, but the payments can be substantially higher when you renew in five years at 5.5%. This is something referred to as 'Payment Shock'. (To be discussed in an upcoming newsletter... hint hint, watch for it!) Our Minister of Finance, Jim Flaherty, deemed it necessary that all fixed 1, 2, 3, and 4 year, and all variable mortgages qualify at the benchmark rate. The benchmark rate in Canada is currently set at 5.34%. This translates to buyers affording less because of inflated interest rates that act as a safety net.The only way to avoid qualifying at the Benchmark rate is to opt into 5 to 10 year fixed terms. These terms allow you to qualify at the contract rate (the rate being offered by your Mortgage Advisor). The difference in the contract rate and the benchmark rate can be very significant. Here is an example:Suzie and Charlie want to purchase their first home. After speaking with their Mortgage Advisor, they are given two options:1. $400 000 with the 5 year fixed at 3.59%, or2. $335 000 with the 5 year Variable at Prime-0.4% (2.6%)Even though option 2 has a lower interest rate, it needs to be qualified using the Benchmark rate (5.34%), so their purchase becomes noticeably less.To sum this up, fixed rates and variable rates are two completely different products and are actually very independent of one another. I understand this can be a very confusing topic, so don't hesitate to contact me with your questions!
Bank of Canada maintains overnight rate target at 1/2 per cent
The Bank of Canada today announced that it is maintaining its target for the overnight rate at 1/2 per cent. The Bank Rate is correspondingly 3/4 % and the deposit rate is 1/4 per cent.
CPI inflation rose to 2.1 % in January, reflecting higher energy prices due in part to carbon pricing measures introduced in two provinces. The Bank is looking through these effects, as their impact on inflation will be temporary. The Banks three measures of core inflation, taken together, continue to point to material excess capacity in the economy.
Overall, recent data on the global and Canadian economies have been consistent with the Banks projection of improving growth, as set out in the JanuaryMonetary Policy Report(MPR). In Canada, recent consumption and housing indicators suggest growth in the fourth quarter of 2016 may have been slightly stronger than expected.
However, exports continue to face the ongoing competitiveness challenges described in the January MPR. The Canadian dollar and bond yields remain near levels observed at that time. While there have been recent gains in employment, subdued growth in wages and hours worked continue to reflect persistent economic slack in Canada, in contrast to the United States.
Source: Bank of Canada
Canadian home sales edge down from December to January
According to statistics released today by The Canadian Real Estate Association (CREA), national home sales were down slightly in January 2017 on a month-over-month basis.
- National home sales declined 1.3% from December 2016 to January 2017
- Actual (not seasonally adjusted) activity in January was up 1.9% from a year earlier
- The number of newly listed homes dropped 6.7% from December 2016 to January 2017
- The MLSHome Price Index (HPI) in January was up 15.0% year-over-year (y-o-y)
- The national average sale price was little changed (+0.2%) y-o-y in January
Sales activity was down from the previous month in about half of all local markets, led by three of Canadas largest urban centres: the Greater Toronto Area (GTA), Greater Vancouver, and Montreal.
Actual (not seasonally adjusted) sales activity was up 1.9% compared to the same month last year. While sales were up from year-ago levels in about two-thirds of all local housing markets including in the GTA, Calgary, Edmonton, London and St Thomas, and Montreal, they were down significantly in the Lower Mainland of British Columbia.
The number of newly listed homes dropped 6.7% in January 2017, the second consecutive monthly decline. New listings were down in about two-thirds of all local markets, led by the GTA and environs across Vancouver Island.
With the monthly decline in new listings surpassing the decline in sales, the national sales-to-new listings ratio jumped to 67.7% in January compared to 64.0% in December and 60.2% in November.
The ratio was above 60% in about half of all local housing markets in January, the vast majority of which are located in British Columbia, in and around the GTA and across southwestern Ontario. A monthly decline in newly listed homes further tightened housing markets that were already in sellers market territory.
There were 4.6 months of inventory on a national basis at the end of January 2017 unchanged from December 2016 and a six-year low for the measure.
The imbalance between limited housing supply and robust demand in Ontarios Greater Golden Horseshoe region is without precedent (the region includes the GTA, Hamilton-Burlington, Oakville-Milton, Guelph, Kitchener-Waterloo, Cambridge, Brantford, the Niagara Region, Barrie and nearby cottage country). The number of months of inventory in January 2017 stood at or below one month in the GTA, Hamilton-Burlington, Oakville-Milton, Kitchener-Waterloo, Cambridge, Brantford and Guelph.
In the Fraser Valley and Greater Vancouver, prices have receded from their peaks posted in August 2016. That said, home prices in these regions nonetheless remain well above year-ago levels (+24.9% and +15.6% respectively).
Meanwhile, benchmark prices continue to climb in Victoria and elsewhere on Vancouver Island together with Greater Toronto, Oakville-Milton and Guelph. Year-over-year price gains in these five markets ranged from about 18% to 26% in January.
By comparison, home prices were down 2.9% y-o-y in Calgary and by 1.0% y-o-y in Saskatoon. Prices in these two markets now stand 5.9% and 4.3% below their respective peaks reached in 2015.
Home prices were up modestly from year-ago levels in Regina (+3.8%), Ottawa (+3.7%) and Greater Montreal (+3.1%). In Greater Moncton, home prices for the market overall held steady (-0.2%), reflecting an increase in townhouse row units prices (5.8%) that was offset by a decline in prices for one-storey single family homes (-1.0%).
The actual (not seasonally adjusted) national average price for homes sold in January 2017 was $470,253, almost unchanged (+0.2%) from where it stood one year earlier.
The national average price continues to be pulled upward by sales activity in Greater Vancouver and Greater Toronto, which remain two of Canadas tightest, most active and expensive housing markets.
That said, Greater Vancouvers share of national sales activity has diminished considerably over the past year, giving it less upward influence on the national average price. The average price is reduced by almost $120,000 to $351,998 if Greater Vancouver and Greater Toronto sales are excluded from calculations.