I should have known something was up when the mortgage rep at my local bank wouldn't tell me what interest rate the bank was offering me on a fixed-rate loan.
"I want to lock in the longest possible sub-3 per cent rate," I told the employee of a major Canadian bank which shall remain nameless.
"Why?" he asked. "You can get a much better rate for a variable-rate mortgage." And then he proceeded to show me how I would save big money if I made payments on a variable-rate mortgage. When I walked out of the bank half an hour later, head spinning with numbers, I still didn't know what my bank was charging on a fixed-rate mortgage.
I wasn't having any of it. Having spent years writing about residential real estate and financial markets, I saw this variable mortgage idea for what it could end up being: A trap, and one set for me by my own bank. Here's why.
Mortgage lenders say Canadians are finding variable-rate mortgages more attractive today, even though this is could prove to be one of the worst times possible to get one. (Stock photo: Getty Images)
Most Canadians (about 80 per cent) get a fixed-rate mortgage that locks in a rate for five years. But a small fraction have always gotten variable-rate mortgages, which are cheaper. They have a lower rate, but the rate moves up and down constantly with market interest rates, changing your interest payments.
The way the mortgage lending industry tells it, it's consumers who are suddenly interested in variable-rate mortgages. That's because the difference in rates between fixed and variable mortgages have widened, and variable mortgages are now a good bit cheaper than fixed-rate ones.
With house prices soaring in some Canadian markets, homebuyers are desperate to get as large a loan as they can. But that is precisely the reason they should stay away from variable-rate mortgages: If you're indebted to the hilt, you can't afford a surprise increase in your debt.
If mortgage rates were to rise to a more "normal" range of around 5 per cent, from around 3 per cent today, it would add some $600 to the mortgage on an average-priced house in Canada today. In Toronto, it would add more than $900 to an average mortgage, and in Vancouver it would be an extra $1,100.
If you commit to a any mortgage, you run the risk of seeing your payments jump by those magnitudes when you renew. But if you have a variable rate mortgage, you'll start paying higher interest right away.
And it's likely to happen, because of what's going on with interest rates right now. We have today the lowest interest rates the world has seen in 5,000 years of records. Central banks' rates have been on a downward trajectory for decades, from around 20 per cent in the early 1980s to just above zero these days.
In recent years, many who took variable rate mortgages won on the bet, because interest rates were falling, and their payments fell with them. But that's all over now. Mortgage rates can't move down much at all, but they have plenty of room to move up.
That's the scenario mortgage borrowers face today. Their mortgage rate can go only two ways: It can stay where it is, if they're lucky, or it can rise.
And plenty of the world's biggest money experts are saying that inflation is going to make a comeback in the developed world, pushing up interest rates in the coming years -- and evidence is mounting inflation is already returning. Mortgage rates in Canada are about half a percentage point higher today than last fall.
Even the rationale for why variable rate mortgages are so much cheaper today points to higher interest rates. When the difference between rates on different types of mortgages widens, it's because interest rates overall are going up. The worst possible time to get a variable-rate mortgage.
At a time when Canadian household debt is already at very risky all-time highs, pushing mortgage borrowers to take on a more volatile and unpredictable mortgage can only be described as irrational and irresponsible.
So why are lenders doing this? Well, remember when the federal Liberals announced tough new mortgage rules last fall? Among those rules was the introduction of a "stress test" that requires lenders to see if a borrower still qualifies at the Bank of Canada's posted mortgage rate. It's about 1.5 percentage points higher than the rate actually offered at banks.
Mortgage comparison site Ratehub estimated that homebuyers would need at least 20 per cent more income to afford the same house as before the rules.
According to the mortgage professionals, this is having a serious impact on mortgage borrowing right now.
"The recent changes are having a cumulative negative impact on the mortgage market and ultimately on the Canadian consumer," Paul Taylor, head of industry group Mortgage Professionals Canada, told the House committee on finance last week. He pleaded with the government to "wait for the remaining existing changes to make their way through the market before implementing any further changes."
Lenders are evidently seeing the bottom end of the housing market struggle with the new rules. At the same time, they are seeing rising interest rates on the horizon. So why not place the risk of rising interest rates on the homebuyer, while at the same time offering what appears to be a cheaper loan? That, in essence, is what a variable-rate mortgage does.
The question is, will interest rates still be low enough five years from now for you to afford it? That's a pretty big gamble these days.
In the coming months, real estate data will show just how many people were priced out of the market by the new rules -- and how much of a shift there has been variable-rate mortgages.
Not me. In my own homebuying adventure, I ended up going with an independent lender who had no trouble telling me what a fixed-rate mortgage would cost.
Three days after signing with that lender, I got a text message from the rep at my bank, finally offering me an interest rate on a fixed-rate mortgage. Couldn't ask for a clearer sign that if I'm not taking a risky loan, this bank doesn't want my business.
So be careful if your mortgage lender is trying to get you excited about a variable loan. It might just be a case of them failing their own "stress test."
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Finance Minister Bill Morneau's new mortgage rules, enacted in October, 2016, could "reduce the risk of a knock-on to the Canadian economy" from any possible corrections in Toronto or Vancouver, BMO economist Sal Guatieri told The Financial Post. The Bank of Canada has long warned that interest rates could go up again — and Canadians should ensure they can still afford to pay. Now they have to prove it to lenders.
First-time homebuyers tend to be the "primary users of mortgage insurance," according to Royal Bank of Canada. So the "stress test" could make it difficult for them to borrow as much as they'd like to. In a way that's a good thing. It means they can only borrow what they can afford. But it also means they won't have as much purchasing power in a hot market. That said, the new rules are probably protecting them from a debt burden they can't handle.
Home sales could fall as much as eight per cent in the first year after the new mortgage rules come into effect, Bloomberg reported. Of course, that depends on what buyers do. They may decide not to buy homes at all, they could also opt to buy cheaper properties, or dig into their savings just to afford their purchases, finance department spokesman Jack Aubry told the news agency. Meanwhile, the Bank of Canada says home sales could fall by as much as 10 per cent, while prices could drop by five per cent.
Stricter mortgage rules could mean that borrowers start turning to "shadow-banking," according to Canaccord Genuity. "Shadow-banking" refers to activities that happen outside traditional financial institutions. While bigger banks lend money using cash from deposits, shadow banks use money from groups of investors and aren't subject to the same scrutiny as major financial firms. They could therefore be more likely to hand out bad loans.
Canada's economy as a whole grew by $4.2 billion from the fourth quarter of 2014 to the second quarter of 2016, according to Macquarie Research. But residential investment increased by 3.5 times that amount ($14.7 billion) in the same time frame as housing activity skyrocketed in Vancouver and Toronto. Watch for residential investment to decline.
There are concerns that the new rules don't create an even playing-field for mortgage lenders outside the big banks, The Globe and Mail reported. Alternative lenders such as Home Capital Group, which generally target riskier borrowers with lower credit scores, may find themselves scrambling for business now that mortgage clients have to qualify for loans at higher interest rates.