Monday, March 29, 2010

Tightening the vice - it begins

We've been warned, and today, Canadian banks announced that they are hiking fixed mortgages rates.  While the Bank of Canada has announced repeatedly over the past year or so that rates would be held until June, banks aren't waiting.  Nor should this be surprising to mortgage holders, as fixed rates based on bond yields typically will begin to rise before the central banks hike rates.
The move comes as many Canadians with variable-rate mortgages have been anxiously watching for signs of exactly when the Bank of Canada will begin hiking interest rates, in a bid to wait and lock into a fixed-rate mortgage at what they hope will be the ideal time.
While the Bank of Canada may nicely "announce" when they are going to change their rates, banks don't have to give notice.  It's based on long bond yields which (if you've been paying attention) have been steadily rising.  The 30 year treasury is poised to break a signicificant resistance level (this doesn't guarantee it will), but IF it does, it likely indicates targets for 30 year mortgages are likely to head back to historical norms in the range of 7-8% (within the next 2 years).  If you're interested, Karl Denninger has an outline of the inverted Head and Shoulders pattern in the 30 year treasury yield (and it's implications) in "On Deficits and Debt Financed Government".  You've been warned.

Getting back to the Globe article though:
Rising rates present a dilemma for many homeowners who face decisions about whether to lock variable rate loans into fixed terms or ride it out and hope that rates will come down again in 2011 as the economy slows and inflationary pressures subside.
Yes, but remember, those fixed prices you think you'll have the option to lock in at will not be available when you (later) want to lock in.  They'll be a hundred (or more) basis points higher.  
Potential homebuyers entering the market also must consider rising rates when they decide to bid on a house. Is it better to wait until rising rates have cleared out some potential bidders or will a flurry of buyers and sellers spooked by the prospect of higher mortgage costs affect the supply-demand balance?
Wow, REALLY?  Buyers shouldn't just consider the current monthly cost associated with a mortgage?  They should perhaps factor in future interest rate hikes, inflation, cost of living increases associated with housing, the HST, they're future earnings potential...etc?  Why?!? Maybe because a house isn't a "one time cost", and the buyer is spreading their amortization over the bulk of their lifetime, spending hundreds of thousands of dollars that the buyer doesn't currently have?   Hoocoodanode!?!
Historically, staying short-term and flexible has been the best strategy, but banks usually advise that locking in at still-attractive longer-term rates of five years and more is always a good bet for many consumers who want to ease their risk.
Short term and flexible is the best plan?  Why this sounds awfully like RENTING!  Thank goodness the bank's "advice" is to instead lock in at "longer" fixed rates, since this "eases their risk".  First off, Canadians don't have "longer" fixed rates.  They have 5 years, 7 years, and at most 10 year fixed rate mortgages.  In the US however they actually have the option of locking in for a 30 year they don't have to face renewal risk every 5 years.  Who knew that the US housing basket case actually has lending practices that actually make sense for a consumer.

Secondly, locking in for a 5 year term does NOT reduce your risk, it just moves it out.  You pay a guaranteed rate for your term, but then you (potentially) face rate renewal shock.  Let's say you lock in today at the (new) 5 year posted fixed rate at 5.85% with a 250K mortgage over 25 years (I know, who takes a 25 year am these days).  You would be looking at monthly payments of $1577.  In 5 years you're up for renewal, but the new 5 year rate is at 7.5% (this is still less than a 50BP rise each year).  After 5 years, you still have $224 112 owing on your principle (congrats, you've managed to pay off a measly 5K per year in principle...with the rest going to interest).  Finincing over 5 years 20 year AM, at 7.5% you'll see your payments jump to $1790/month (a 13.5% increase, or over $200/month more).   And for those that say "that's fine I'll get a raise to match"...OK, except that giant sucking sound you hear is what happens when people have their personal disposable income cut by $200 a month solely to service debt.  That's money that's gone, that can't be spent on anything useful, and that doesn't bode well for anyone other than the banks and holders of MBS.  Needless to say, that doesn't exactly bode well for the economy as a whole...

Any more advice guys?
If the current bank prime rate of 2.25 per cent rises by 2.5 percentage points to 4.75 per cent, a homeowner with a variable mortgage should expect to pay about 30 per cent more on their monthly mortgage, says Robert McLister, a mortgage planner and editor of the Canadian Mortgage Trends website.
“If that causes you discomfort then perhaps a fixed rate's where you want to be and if a fixed rate is where you want to be...if you're closing in the next six months, I suggest people do that quickly.”
Generally, long-term fixed rates rise by about half of the variable rate, he said.
While the fixed versus variable decision is specific to each individual, Mr. McLister said if prime rates spike by more than 2.5 percentage point, odds are good homeowners will save money in a five-year fixed rate mortgage.
Potential homebuyers should get their pre-approval applications in fast and expect delays in pre-approvals due to increased application volumes, he said. And homeowners' with mortgages up for renewal would also be wise to lock in rates as far in advance as possible.
Typical broker/media  publication jackassery spouting off that you must buy now or never.  I mean seriously, ask a broker how interest rates affect housing prices, and what you should do about it,  and this is what you will hear:

1) Mortgages rates have never been lower, so now's a GREAT time to buy.
2) Mortages rates are starting to go up, so you better hurry, because now's a GREAT time to buy.
3) Motages rates are falling, but you better hurry while they're low, because now's a GREAT time to buy.
4) Mortgages rates are steady, but they won't stay that way, so you better hurry, because now's a GREAT time to buy.
5) Mortgages rates are very high, but are only going higher, so you better hurry, because now's you're LAST CHANCE to buy.

(The irony is that if have you have cash, and are in scenario 5, it MIGHT actually be a good time to buy, because prices should be utterly annihilited by that point).
CIBC chief economist Avery Shenfeld said mortgage rates hikes are a trend consumers should expect to continue.
“Once the Bank of Canada starts pushing up short-term interests rates, and even in anticipation of that, it tends to spill out across the rest of the curve."
He predicts the Bank of Canada will gradually raise key lending rates this summer, resulting in an increase of 0.75 per cent to one per cent by the end of the third quarter.
That would raise the average prime rate at the banks from 2.25 per cent to three per cent, which could tack on three-quarters of a per cent to the rates of homeowners with floating mortgage rates, Shenfeld said.
“Consumers are forewarned that when they look at borrowing today they have to factor in potentially higher costs,” he said.
“Consumers have to be aware in taking on debt at historically low interest rates that down the road they will be higher and have to leave room for their ability to pay those higher rates.”
Gee, ya think?  And of course the problem with taking on debt at historically low rates is that people GORGE themself with it, vastly overpaying for the underlying asset (in this case houses).   You don't hear the house pumping media say that consumers need to look further down the road very it should be OBVIOUS to anybody that decides to take on a 6 figure debt financed by someone else.  Sadly, the entire concept of "renewal risk" is something most new homebuyers haven't yet experienced.  They've grown up in a period of declining rates, and appreciating home prices...a rude awakening is coming to many.

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