“Complexification” of Mortgage Rates

This is probably going to be the most interesting mortgage tidbit you’ll read this month! And yes, I did make up a word.

Comparing rates is going to get a whole lot harder!

We are now going to see at least 3 to 4 different rate classes for mortgages in Canada.

Preamble
The Canadian mortgage market used to be very simple. We had the big banks, credit unions, and trust companies.

Almost 20 years ago, the Canadian government and CMHC decided to put their weight behind Canadian mortgages by guaranteeing an insurance payout. Yes, the Canadian taxpayers are on the hook if CMHC goes under.

In the United States, Fannie Mae and Freddie Mac (the insurance agencies down south) had no such guarantees. Before we go any further, Canadian mortgage regulations were and are much tighter than American mortgage regulations.

Canada also allowed lenders to pay for mortgage insurance for their borrowers, even though it may not be required. Borrowers would not know that their mortgage is insured, rather the lender would pay for and insure the mortgage on the “back end” in order to make the mortgage less risky. IE if the borrower does not pay, the insurer would pay the lender (just as they would pay if the borrower had less than 20% down payment and was charged for insurance themslves).

Furthermore, Canada allowed its mortgage lenders to securitize their mortgages and sell them to investors. The securitization (the process of taking assets and transforming them into a security) of mortgages allowed investors to purchase pools of mortgages, knowing there would be a guaranteed return. The return here is the interest rate on the various mortgages.

Now, mortgage investors are looking at two things: investment return and mortgage risk. The lower the risk of an investment, the lower return an investor is willing to see. Because lenders can insure their mortgages, they were able to sell them to investors at higher prices. Conversely, investors provided lenders with cheaper money to lend out, which in turn, provided for better interest rates for borrowers.

What ended up happening was the emergence and major growth of mortgage finance companies (Monoline Lenders). These lenders, encouraged by access to cheap capital, set up efficient mortgage underwriting (approving) operations and were able to provide flexible mortgage products and better-than-the-banks interest rates for their clients.

The overwhelming majority of these lenders’ mortgages are insured by the lender, packaged up and sold to investors.

PHEW, that was a mouthful!

So What’s Changed/Changing?

New Mortgage Rules Part 1
The government announced new mortgage rules. As of October 17th, 2016, all insured mortgages must pass a stress test. What this means is that people who had under 20% down payment, would have about a 20% decrease in their affordability. Ouch.

New Mortgage Rules Part 2
Starting November 30th, 2016, all mortgages that are insured (even “back end” insured by lenders), must be approved as though borrowers have less than 20% down payment. Further, the cost for lenders to back end insure their mortgages is going to more than double.

OK, seems pretty innocuous right? Wrong – it’s pretty bad actually…

What this means is that mortgages that would normally have been safe, conservative investments for lenders, are now much harder to come by. This is due to CMHC not insuring many mortgages that would have normally been insured in the past. Remember, an insured mortgage (even if the borrower does not know it is insured on the back end) is a safer investment, regardless of the loan to value that the lender has. All of this boils down to an increase in interest rates for many transactions!

Example: A mortgage loan with 10% down payment, or 90% loan to value of the property, will have an interest rate, of lets say, 2.49%. Now, if we take this same loan and increase the down payment to 20%, you would think that since the lender has a lower loan to value, they would have a lower risk. This conventional wisdom is wrong now because this mortgage may no longer be insured by CMHC. And if the lender does back end insure the mortgage, it costs them more to do so than previously. This cost is being passed on to borrowers.

We will now have lower rates for loans where borrowers pay less than 20% down payment because they will be paying the insurance against any mortgage non-payment.

Commentary: One could argue that lenders who do not back end insure, namely the big banks, will have an advantage over mortgage finance companies that overwhelmingly back end insure. However, this argument has been proven wrong as RBC already changed their rate tables to include lower rates for mortgages that are insured or insurable (25 years amortization and under) and those that are not.

Since the new rules are coming into effect tomorrow, we have already seen announcements coming out from various lenders and we can expect interest rates to look something like the table below:Insured MortgageInsurable MortgageUninsured Mortgage

Best Rates

Higher Rates

Highest Rates

Client Pays Insurance (Generally less than 20% down Payment)

Lender Pays Insurance (Passes off Higher Costs to Borrower)

Cannot Obtain Insurance

Rate of X

Rate of X + 0.15%*

Rate of X + 0.25%*

*Best guesses with info available as of November 29.

Requirements for Insurance:Uninsured Can be: Mortgages for Purchase Transactions Only Mortgages for Refinances Owner Occupied or Second Homes Only Rental Property Mortgages Purchase of a property whose value is under $1M Amortization over 25 years Maximum Amortization of 25 Years Minimum Credit Score of 600

Based on what I’m seeing, it seems as though there will be at least three different rate classes in Canada going forward, with one lender providing up to five different rate classes…

On the Plus Side…?

In all honesty, I’m not sure there is a plus side. These measures have decreased affordability and increased interest rates! Furthermore, the measures have created a climate that benefits the big banks because they do not have to back end insure their mortgages.

The goals of the government here seems to be to cool the housing market and decrease home debt by attacking mortgage lending. There are arguments that these measures may not work for specific markets but the general consensus is that it will.

Mortgage Brokers, Realtors and borrowers will have to tighten their belts in 2017!

But, you’re looking to purchase in the future and your market’s homes do in fact decrease in value, you’ll be better for it when you do purchase.

What’s Next?

Talk to your Mortgage Broker! Preferrably Pinsky Mortgages.

Well, you should always talk to a Mortgage Broker… but if you’re confused that the rate you were quoted is higher than expected, it may be because your mortgage falls into a new, higher rate class. Don’t get discouraged, and get the facts! It’s possible to make your mortgage insurable through education and mortgage engineering!

Thank you for reading this long but informative letter!

Please don’t hesitate to ask me more questions – I’m available for you at your convenience.

Eitan Pinsky
778-990-8950
or Contact Me