Many economic factors are combining to make mortgage renewals a much more difficult process for many Canadians in 2018. Over the past year, interest rates have been on the rise for both variable rate and fixed rate mortgages. At the beginning of 2018, a new stress test was implemented by the OSFI, significantly reducing the home-buying power for many Canadians and limiting their choices when it comes time to renew. These conditions have indeed slowed the housing market across Canada and especially in the GTA. Mortgage renewal time has become less of a rubber stamp, with pleasant surprises on rates and payments, to a more serious financial-decision-process, requiring careful consideration and preparation.
Higher Rates Now the Realty at Mortgage Renewal Time
For the past decade, homeowners have reaped the benefits of lower rates at renewal time, coupled with rising home prices that translated into greater equity. That great feeling of having to pay less, while earning more on your home investment has evaporated. For the first time a decade, homeowners are now faced with higher interest rates when they renew whether on fixed or variable rate mortgages.
Following the global economic recession of 2008, and the oil price meltdown of 2014, the Bank of Canada had held its key overnight lending rate at an incredibly low 0.5 per cent for 7 straight years, until July of last year. Since then, the central bank has had two additional rates increases and there is a great deal of speculation that a forth rate increase may occur as early as this July. These successive increases have put direct pressure on variable mortgage rates and other consumer loan products that are largely determined by a bank’s prime rate, such as a home equity line of credit, aka HELOC.
The market for fixed-rate mortgages, which is more dependent on the bond market as the major capital pool against which mortgage lenders must compete to finance their lending activities, has faced even steeper pressure as bond yields have been rising over the past couple of years.
Both the rise in the bond market and the central bank’s key rate are a result of stronger economic performance in the intertwined markets of the U.S. and Canada. The upward pressure on inflation that we have witnessed on both sides of the border in the last few years, is raising financing and borrowing costs.
Fixed Rate vs. Variable Rate Mortgages
One of the primary decisions you’ll need to consider, at renewal time, is whether to go with a fixed or variable rate. Fixed rates have long been the staple, particularly appealing to mortgagers who want to lock in, for say 5 years, and not have to worry that the interest portion of their payments may go up. However, the rates for fixed mortgages have outpaced variable rates so much, that many mortgage brokers are now recommending applicants take a second look at variable rate options.
Complicating this decision further is the fact that many of the big banks and traditional lenders are faced with a decline in mortgage applications since the stress test went into effect in January, and are therefore competing fiercely in the variable rate market. The variable rates offered by traditional lenders can be more than a full percentage point lower than a fixed rate product of the same term. However, in a world of rising rates, variable rate mortgages often carry greater risks in the short-term:
Faced with a decline in new mortgages since the “stress test” went into effect this year, lenders are now engaging in a mortgage war in the variable-rate market… But in times of rising interest rates, variable-rate mortgages can be risky — borrowers could face considerably higher costs if interest rates were to rise significantly. That may be one of the reasons banks are pushing them so aggressively these days — in effect, they offload the risk of rising interest rates from the lender to the borrower. – Huffington Post
NAFTA Uncertainty Creates Strong Case for Variable Rate Mortgages
Most of the models that predict the Canadian economy will keep growing, and therefore keep putting upward pressure on variable rates, are under the assumption that NAFTA will continue with business as usual between Canada and the U.S. We’ve already seen signs that the economy is slowing in 2018, with job losses and a declining housing market, while trade relations with the U.S. continue to deteriorate. Leading economic experts believe that if the situation over NAFTA is not resolved soon, the Bank of Canada will have no choice but to put further rate increases on hold:
The economy is slowing, and negotiations over NAFTA are still unresolved,” says [Benjamin Tal, senior economist at CIBC]. “That’s a big deal, and if NAFTA is terminated by the U.S., we believe any rate increases will be put on hold. – Maclean’s
Fallout from the recent G7 meeting in Quebec doesn’t bode well for a quick resolution to NAFTA, as President Trump is threatening new tariffs, in addition to steel and aluminum, on the Canadian auto and dairy sectors. The government of Canada is standing firm on its announcement of counter-tariffs on a variety of American goods to the tune of $16 billion. All of this sabre rattling could lead to a trade war, which is sure to put the brakes on the Canadian economy and thoughts of additional rate hikes.
OSFI Stress Test Makes It Harder to Switch Lenders at Renewal
Another consideration, amidst all the competition for mortgages, is whether to stay with your current lender at renewal time. Your current lender can have a bit of leverage here, because if you stay with them, you don’t need to pass a new financial stress test. If you go with a new lender, that is federally regulated such as one of the big banks, you’ll need to prove that you can cover your mortgage payments if the rate you’re offered, or the 5-year average rate posted by the Bank of Canada, goes up by two full percentage points, whichever is greater.
Mortgage lenders know that the majority, over 80 per cent, of their customers stay with them at renewal time and most people can expect a bit of sticker shock in a world of rising rates and bond yields, which increases the financing cost of mortgages. Lenders also know that a great deal of mortgage debt is up for renewal in the next year, with some sources estimating that, “Nearly half of existing mortgages face renewal in 2018” (Financial Post), representing a significant opportunity for lenders to make more money at renewal time, beyond the increased costs of financing your mortgage:
Financing costs may legitimately be going up, but according to Bank of Canada numbers, some $700 billion of mortgage debt is up for renewal in the next 12 months, which is going to give the big banks ample opportunity to renegotiate loans in this era of new laws — and possibly squeeze more money out of their existing customers. Borrowers don’t have to undergo a stress test when they renew with their existing lender — only when they switch. That gives the existing lender a window to offer a higher rate, as they know the borrower may not be in the best position to leave. – CBC
Prepare for Your Mortgage Renewal Well in Advance
Start preparing for your mortgage renewal process well in advance of your renewal date. If you take a good look at your finances, or speak with your financial advisor, you’ll get a sense of how your income and expenses may have changed since you first obtained your mortgage, or since your last renewal date. Knowing what level of payments you can afford on your remaining mortgage debt will help inform your choices.
Think about the level of risk you might wish to acquire via a fixed rate or variable rate mortgage. Do you have the financial leeway, and the stomach for the extra risk associated with variable rate mortgages and the increase in the interest payments that you will pay when rates go up? Fixed rate mortgages protect you against short-term risk, but also have higher penalties if you want to break your mortgage early, if for example, the spread between variable and fixed rates continues to increase, making the variable rate option even more attractive than it is now.
If you’re not sure that you can easily pass the new stress test and want to opt for your current lender, if you speak with them well in advance, you’ll know exactly what rates, payments and terms they’re prepared to offer. Lenders will often hold a rate for you for 3 or 4 months, if you’re prepared to renew with them; however, they may require you to immediately start your new mortgage term at the new, and often higher, rate for the trade-off of locking in now, as rates are expected to rise in the short-term.
Hatch a Plan for Your Mortgage Renewal
Of course, getting a great rate upon renewal is important, but the terms and conditions are also important as well. At Hatch, we strive to offer some of the most competitive mortgage rates across Canada, and we also have decades of experience in the industry so that we can help you get terms ideally suited to your financial needs through our network of lenders. Simple fill out our online mortgage application and we’ll get cracking on the right mortgage for dream nest.