Mortgage rates in Canada are set to drop again with BMO leading the charge with their new 2.99% 5 year fixed rate. Why is this happening and what does the future hold. To hear Marcus Tzaferis talk about these new rate drops live on CBC click here.
Mortgages in Canada are priced in accordance with where Canadian Government Bonds are trading. With all of the uncertainty in financial markets, around the world Bonds have built up a loyal following over the past few years. The consistent demand from investors for Bonds is keeping their yields very low. Since most mortgages in Canada are guaranteed by the Canadian Government that makes them equal in risk weighting to Government of Canada Bonds (in fact when you think about it Canadian mortgages backed by the government have both the government backing and the underlying real estate as security, leaving the investor very secure). Since the market for creating and selling these Canadian Government insured mortgages is predominately controlled by Canadian Banks they are able to control interest rates on these mortgages with relative ease. You can see the current Government bonds rates here
We know from reading the financial statements of our Canadian Banks that they make a good profit when they are lending out 5 year fixed rate mortgages at about 1.4% over where the Government of Canada bond yields are. For those of you who don’t have a Bloomberg terminal connected to your hip Government of Canada Bond yields are at about 1.4% for the 5 year term. This would lead us to believe that 5 year fixed rates should be closer to 2.8% rather than the currently Bank advertised 4.04% rates or even the deeply discounted 3.09% rates that some great mortgage brokers have access to (wink, wink, nudge, nudge).
Canadian Bonds have been trading in this range for some time now, in fact late December saw them reach 1.2% but there are a few other factors at play in this market. The Canadian Government is concerned with the debt loads that Canadians are taking on. They are trying to limit banks from providing an unlimited source of funds to Canadian homeowners. It is generally understood by the players in this market that advertising rates of 2.99% makes the Bank of Canada and the Canadian Government uneasy, but it shouldn’t! As long as this is done properly Canadians should be rewarded. They should have access to naturally occurring fixed mortgage rates.
Bank of Montreal has created a mortgage product that has some rather strict limitations, and it seems that everyone is talking about it. But along with the strict limitations are some features that could be replicated by other lenders to make the bureaucrats happier.
- Lower available amortizations: By limiting the maximum amortization on the loans to 25 or even 20 years the lower interest rate will not necessarily result in a much lower payment, only in a faster repayment of debt which is good for the customer.
- Increasing the qualification criteria for the loans to be stricter with income and credit requirements to ensure that the rate is used a reward to those clients who have a solid repayment history.
- Using the increased margins in current mortgage rates to offer clients more features that typically increase the rate on a mortgage (i.e. reduced penalties and increased pre-payment privileges).
To make things a little more complicated the Bank of Canada came out today and hinted that it was more likely to increase rates sooner than it initially expected. They cited in their press statement that easing global financial market tensions, perkier U.S. data and households adding “to their debt burden” suggest a “marginally improved” economic outlook than previously thought. This is despite the strong Canadian dollar. The statement repeated that ” there is considerable monetary stimulus in Canada”, but did not repeat the MPR remark that the inflation outlook assumes a gradual tightening of policy over the forecast period (which presumably runs through end-2013).
Still, the message is clear: while rates are unlikely to increase in the near term, the next move is more likely to be up rather than down, and could well emerge sooner than we currently anticipate (2013Q4). The loonie leaped a quarter cent after the release.
We want what is best for the consumer, there is no doubt that the Banks have a great deal of control on the Canadian financial markets but this should not limit the rates good quality borrowers are able to obtain.