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blog, Mortgage Education, Mortgage Refinance

Fixed vs. Variable: Which Mortgage is the Better Choice?

Compared to fixed-rate mortgages, variable-rate options cost less for the borrower — even when rates are expected to rise

variable-vs-fixed-consider-the-numbers

By James Harrison
Mortgages.ca

 

When you’re thinking about what kind of mortgage you need, you might be tempted to do what many Canadians do without giving it much thought: They choose a fixed rate.

Fixed-rate mortgages are the most common type of home loan. According to a report by Mortgage Professionals Canada, 72 per cent of Canadians who bought homes in 2016 or 2017 secured fixed-rate mortgages.

Especially when news media stories predict interest rate hikes in the near future, borrowers grasp onto fixed-rate mortgages. They’re willing to pay a rate premium in exchange for a consistent monthly payment and a feeling of certainty.

 

But they’re not doing themselves any favours.

 

The media hype around possible interest rate hikes is often inaccurate, and the fear is fuelled by banks who profit from locking borrowers in at the premium rates attached to fixed-rate mortgages. These loans are simply more profitable than variable-rate mortgages, so banks like to create the impression that a five-year fixed mortgage is the obvious choice.

The fact is, a variable-rate mortgage is almost always a better choice for borrowers who want to pay less for their loan. And that’s true even when rates are expected to go up.

 

Feeling the variable-rate jitters?

Many borrowers are feeling nervous now because the Bank of Canada has hiked the key interest rate five times since July 2017, from .50 to 1.75 per cent, and economists have predicted more raises in 2019.

Those nerves are understandable. But when you do the math, and when you know the history of how interest rates move in Canada, it becomes clear that a variable-rate mortgage can still save you thousands in interest payments compared to a comparable fixed-rate product.

Not only that, it’s possible to reduce the risk and maximize the benefit of a variable-rate mortgage by making strategic monthly payments that are a little higher than they need to be from day one.

But more on that smart strategy in a minute. First, let’s look at the reasons why variable mortgages are a better choice.

 

Why variable-rate mortgages cost less

Variable rates are typically lower than fixed rates. But the spread between the two types of mortgages can vary.

That’s because variable mortgage rates are tied to the prime rate. When the Bank of Canada’s prime rate goes up, variable mortgage rates follow. On the other hand, fixed mortgage rates are primarily influenced by the yield on government bonds of the same term. The two types of mortgage are influenced by different factors, so the spread fluctuates.

When rates for five-year fixed mortgages are at least 0.5 per cent higher than rates for comparable five-year variable mortgages, it makes more mathematical sense to choose a variable product.

The spread is important because when it’s 0.5 per cent or more, it’s extremely unlikely that rates will go up enough during the five-year term of a mortgage to make a variable mortgage more expensive than a fixed one.

We know it’s unlikely because we can look at how the Bank of Canada’s has historically adjusted its prime rate, which in turn causes variable mortgage rates to go up or down.

When the Bank of Canada implements federal monetary policy by adjusting the prime rate, it rarely does so quickly. It moves the rate up or down by 0.25 per cent with each adjustment, then it waits to see the effect on inflation.

As well, given historical trends, it’s extremely unlikely that rates will only go upward over the five-year term of a mortgage. They may go up for a while, but then they’ll go down again because of the cyclical nature of the economy.

 

We can apply our understanding of history and make some reasonable predictions about the future. Looking forward at the next five years, we see that while rates may go up a few times over the next two or three years, an economic recession is due in 2020 or 2021. Rate decreases are the federal bank’s likely response.

With the current spread between five-year fixed and five-year variable rates, the prime rate would have to go up by 0.25 per cent about seven or eight times over the next five years for you to start losing more with a variable-rate mortgage than you would with a fixed-rate mortgage. It would have to stay up, too, with no rate drops in between.

But that scenario is beyond imaginable for most people in the financial industry. If the prime rate were to go up — and only up — seven or eight times in less than five years, we’d be experiencing a widespread economic meltdown the likes of which we’ve never seen. It’s extremely unlikely.

 

The exception to the ‘variable is better’ rule

When we look at historical data, we can see the spread between fixed and variable mortgages is almost always greater than 0.5 per cent in Canada. Over the past decade, the spread has usually stayed between about 0.7 and 1 per cent.

There was a short period in 2016 when rates for fixed mortgages were low and the spread between fixed and variable was a mere 0.3 per cent. During that period, there was a strong reason to choose a fixed mortgage. But it’s extremely unlikely that we’ll see rates and spreads like that again anytime soon.

 

Why variable rate mortgages are more flexible

In addition to offering lower costs, variable rate mortgages allow borrowers more control and flexibility than a fixed mortgage.

In a variable mortgage, the borrower can break the mortgage at any time with only a three-month interest penalty. Compare that to fixed rate penalties, which are equal to either three-months interest or the IRD, or interest-rate differential calculation, whichever is higher.

For example, on a $500,000 variable-rate mortgage, the penalty for breaking it would be about $3,000 compared to a $20,0000 penalty on a comparable fixed-rate mortgage with a big bank.

No one plans to break a mortgage, but life happens. And avoiding a $20,000 penalty can make a dramatic difference in your life when you’re going through unexpected life changes.

In addition, a variable-rate mortgage allows you to lock into a fixed rate at any point. But it doesn’t work the other way. A fixed-rate mortgage cannot be changed to a variable one during the length of the term. You’re stuck with a fixed rate for the entire five years, no matter which way rates go.

How to reduce the risk of a variable mortgage

We suggest our clients choose a variable mortgage, but that they make monthly payments as if they had chosen a fixed one with a higher rate of interest.

That means they structure their household budgets in order to pay more than the minimum payment with each monthly payment. An extra $200 or $300 per month goes toward paying off principal instead of interest before rates have had time to increase. So the borrower saves thousands in interest over the life of the loan. And they pay down thousands more of the principal while they wait for any potential rate increase.

The strategy also builds in a buffer of three or four potential rate increases. Even if the prime rate goes up steadily for a year or two, the borrower is already used to a higher payment and their household budget is not affected by the rate changes.

In the 11 years I’ve been in the mortgage business, I’ve never once had a client regret going variable, but I’ve had many regret going fixed.

What to do if rates start to rise

The option to go fixed always exists for borrowers in variable mortgages. And when the news is full of predictions that interest rates are going up, clients sometimes call to ask about locking in to a fixed rate.

We never advise our clients to take the option of going fixed.

Instead, we suggest they increase their payments as if they did lock in. Or we suggest they break the current variable-rate mortgage and set up a new one with an even better variable discount.

What to look for in a fixed mortgage

As a licensed mortgage broker, I consider it my responsibility to explain the pros and cons of fixed-rate and variable-rate products. And I keep an eye on the spread, so I know I’m always giving up to date advice on which option makes more mathematical sense. But some borrowers will choose a fixed mortgage every time, no matter what the math indicates.

In that case, and also when the spread does drop below the 0.5 per cent mark, it’s important to choose the best possible terms for a fixed-rate mortgage, paying close attention to prepayment penalties.

While most borrowers have no intention of breaking their mortgage, about 60 per cent of Canadians do. So if you’re going fixed, you must look carefully at the penalties you’ll incur if you end up having to break it.

We recommend our clients choose non-bank lenders (also known as monoline lenders) when they do choose a fixed-rate mortgage. These dedicated mortgage lenders calculate IRD penalties differently than banks do. While banks use the posted rate to calculate the IRD, monoline lenders use a rate that’s an average of about 1.5 per cent lower. That means a significantly lower penalty when your loan is with a monoline lender.

 

How a mortgage broker helps

As a licensed mortgage broker, I help my clients get the mortgage that’s right for them by negotiating on their behalf with banks, credit unions, and other mortgage providers for the best rates and products. The cost of my services are free to home buyers. My fees are paid by lenders.

 

Interested in refinancing to reduce your mortgage costs? Call me to set up a free consultation.

blog, Mortgage Education

What Is Your Home Worth?

Everything You Need To Know About Home Appraisals

what-is-your-home-worth

By Scott Nazareth
Mortgages.ca

 

Getting an appraisal is a key part of the process of getting a mortgage. It’s one you should understand when you make an offer on a home, as the appraisal process can move quickly after you make a winning bid.

What is an appraisal?

Appraisals assess the current market value of a property.

Mortgage lenders sometimes require a formal appraisal to determine a home’s value for mortgage purposes — regardless of the price that has been paid for the property. They want to be sure a house is actually worth what they’re lending its purchaser.

This part of the buying process happens after your offer to purchase has been accepted, and before the mortgage has been finalized.

 

Who conducts an appraisal?

A licensed appraiser will determine the value of the home.

In Canada, there are two bodies that license and educate appraisers. They are the Canadian National Association of Real Estate Appraisers and the Appraisal Institute of Canada. Members of both associations are recognized by banks, credit unions, mortgage lenders, and mortgage insurers.

Lenders require that appraisals are done by companies on an approved list. A licensed mortgage broker ideally has knowledge of specific appraisers on the lender’s approved list and will be sure to choose one that is local, which ensures they’re up-to-date on neighbourhood factors that may affect a home’s value.

 

Who pays for an appraisal?

Usually, the purchaser pays the $300-$500 cost of an appraisal.

 

What is included in an appraisal?

1. Value

An appraiser will study the exterior and interior of your property, as well as the land surrounding it. They will also consider the value of secondary structures located on the land.

There are three main ways to calculate the value of a property: the direct comparison approach, the cost approach, and the income approach.

 

The direct comparison approach looks at comparable properties that have been sold in the recent past. Making adjustments by looking at the details of each property, the appraiser assigns a value that the property would reasonably earn on the open market.

The cost approach is a less common way of determining value for residential homes. It’s used when relevant comparable sales data does not exist. This method takes into account the value of the land, plus how much it would cost now to construct a similar home.

The income approach is used for multi-unit properties, where the income related to the property is a key determinant of its value.

 

It doesn’t matter which method your appraiser uses. What matters is the final number, because that affects how much a lender will agree to give you.

 

2. Rental income

When you purchase a rental property, you’ll have to declare what rent you’re going to charge. That can be substantiated by providing a rental agreement with someone who already lives there, or someone who will live there when you move in.

If there’s no rental agreement in place at the time of your purchase, an appraisal will calculate the rental potential by looking at similar properties in the immediate vicinity.

 

3. Photos

An appraisal will include photos of both the exterior and interior of a home, including the attic, piping, and insulation. However, it’s important to note that an appraisal is not the same as a home inspection. They may report on similar things, but an appraisal should never replace an inspection.

appraisals-do-not-replace-home-inspections

When is an appraisal required?

An appraisal is typically not needed when borrowers put less than 20 per cent down because the lender can take comfort from the fact that the loan is covered by insurance. But in some cases — when the value or the condition of a property is in question — the insurer can request an appraisal.

Most borrowers who put more than 20 per cent down are not covered by mortgage insurance, so an appraisal is required. When the property is not insured, there is no guaranteed value in it and the lender needs some other form of assurance that the loan will be repaid. An appraisal is part of that.

But there are two ways to avoid an appraisal.

One way is to use the automated valuation model. There must be enough relevant data for this model, which looks at a database of comparable sales and determine if your property’s price is within an acceptable range.

The other way is when the loan is a small percentage of the total purchase price. If you’ve put 50 per cent down, your lender may waive the right of appraisal.

 

What happens if something goes wrong with an appraisal?

Certain factors in a property’s construction can reduce the appraiser’s calculation of its value. For example, vermiculite insulation, Kitec plumbing, UFFI insulation, and knob-and-tube wiring can all bring your appraised value down.  This can make the property un-financeable for some lenders or may require it to be dealt with prior to closing or with purchase-plus or a hold back.

If an appraisal value is less than the purchase price, the purchaser must make up the difference.

For example, if you paid $749,000 for a home but an appraiser values it at $729,000, the bank will approve a loan based on the lower number. So you’ll have to come up with an extra $20,000 to make up the difference. If you can’t, you may no longer qualify to purchase the property.

Such a situation can be challenging on the short timeline of a home purchase, so it’s a good idea to have a contingency plan. It’s possible that you’ll learn that your home has a problem in the appraisal stage, and it’s never fun to be surprised at that point.

If you’re currently having challenges with an appraisal, contact us to find out how we can help.

Is it worth it to get a second opinion?

Yes. If you’re in doubt, it’s worth the peace of mind that comes with knowing your property was fairly and accurately assessed.

That’s especially true if your first appraisal comes in lower than expected. After a second opinion, the bank may choose one or the other of the reports, or they may take an average of the two. Either way, it’s worth knowing that your property was fairly assessed.

Does an appraisal affect my taxes?

No. It’s not the same as a tax assessment, and your home’s appraisal is not shared with tax assessors.

 

Do you have questions about appraisals or the mortgage process? Book a call to discuss how we can help with your mortgage needs.

blog, Mortgage Education

Don’t Sign That Renewal Letter!

When your mortgage term is nearly up, your lender will offer an easy renewal, but don’t be fooled into signing it

do-not-sign-that-renewal-letter

By James Harrison
Mortgages.ca

 

If your mortgage is up for renewal anytime soon, you can expect to receive a letter from your lender giving you the option to simply sign it and send it back for an easy renewal of your mortgage.

It may look innocuous. But it’s not. Whatever you do, don’t sign it.

The rate your lender is offering in that letter is probably half a per cent — or more — higher than the going rate. Depending on the size of your mortgage, that could cost you tens of thousands of dollars in additional interests charges, not to mention paying off thousands less in principal.

 

Consider your options with a broker

Don’t just sign the renewal letter and send it back. Instead, spend time making an informed decision about the biggest investment of your life.

The first step in your decision-making process is to reach out to a reputable broker. At Mortgages.ca, we help our clients consider their options by asking a few basic questions:

  • Who is your current lender?
  • How much is outstanding on your mortgage?
  • When is the renewal maturity date?
  • What are your financial goals in the next one to five years?

 

During a 10 to 20 minute call, with a bit of questioning, my clients eventually bring up something they hadn’t considered as a significant factor in their mortgage planning. They’re surprised to learn I can help them achieve their financial goals by managing their mortgage.

Most people don’t spend time thinking about the big picture and don’t have a knowledgeable sounding board for the discussion. I consider that a very important part of my role as a licensed broker. I ask questions to learn about their problems, then come up with solutions that will help them meet — and sometimes exceed — their financial goals.

 

Doing the work is worth it

Sometimes people think changing lenders is time-consuming, so they don’t question the renewal letter. They simply accept the bank’s terms without question. But exploring other options is well worth it. Would you trade 45 minutes for a few thousand dollars?

Whatever your informed choice turns out to be with your renewal, the process doesn’t have to be complicated. We can communicate by phone and email. In-person meetings aren’t needed — though they’re always possible.

 

Make an informed decision

When your mortgage term is over, you have three options:

  • negotiate with your lender for a better rate than the renewal letter offers
  • transfer your mortgage to a new lender to get a better rate and/or different terms
  • refinance to get equity out, or to reduce payments by changing the amortization period

 

Timing is important

I advise my clients to make sure their new mortgage is set up approximately three to six months prior to the renewal date.

It’s important to reach out as soon as you get a renewal letter. If you leave your research and decision-making to the last minute, your lender may automatically renew you into an undesirable mortgage — and possibly at a very high rate.

 

Is your mortgage coming up for renewal soon? Contact us about how I can help you make the right choice.

 

 

blog, Mortgage Education

Non-Resident Buyers: What You Need to Know About Buying Property in Canada

The rules for borrowing to buy property in Canada are a bit different for non-residents

Toronto Waterfront

Toronto is among the top places for non-residents to purchase property in Canada. Photo credit: Scott Webb via Unsplash

 

Who can buy real estate in Canada?

Canada welcomes buyers from anywhere in the world, and there are no restrictions to the types of properties people can buy.


What is a non-resident?

It has nothing to do with citizenship.
Lenders define a non-resident as someone who does not earn an income here and who does not file taxes in Canada.


How much does a non-resident need for a down payment?

Lenders typically ask for a larger down payments from non-residents of Canada than they do from resident borrowers. Exactly how much more depends on a few factors. For example:

U.S. Residents

If you’re living in the United States,  plan to use the property rather than rent it, and can provide proof of income and down payment, your down payment must be at least 20 per cent of the total purchase price.

Elsewhere in the world

If you’re living anywhere other than Canada or U.S. and can provide proof of income and down payment, your down payment must be at least 35 per cent of the purchase price. As well, your down payment cannot be a gift from another person or entity.

 

If you don’t have proof of income, you can still get a mortgage, but you’ll need a down payment of at least 50 per cent. A maximum mortgage of $750,000 is available to borrowers in this program, with a maximum amortization period of 25 years. (Note that If you already own property in Canada, you won’t qualify for this special program and will have to provide proof of income and a down payment of at least 35 per cent.)

The Bond

Many non-residents buy condos in Canada’s urban centres. Above, The Bond Condos in Queen West, Toronto. (Photo credit: Condos.ca)

What documents do non-residents need to qualify for a mortgage in Canada?

Unless you can put 50 per cent down, which exempts you from needing to provide proof of income, you’ll need:

  • Proof of income (letter of employment, pay stubs and income tax returns)
  • Proof of down payment (bank statements for the last 90 days)
  • Reference letter from a bank outside Canada
  • Report from an international credit bureau or bank statements for the last six months

 

Will lenders consider rental income as part of a non-resident’s income?

Lenders will not allow applicants to include rental income as part of their income to qualify.


What kind of mortgage rates and terms do non-residents get?

For the most part, provided they meet the mortgage eligibility criteria, non-residents can access the same mortgage products that are available to residents of Canada.

But there are a few restrictions:

  • Some lenders may charge a rate premium for non-residents
  • Non-residents cannot have amortization terms of more than 25 years
  • Non-residents cannot get home equity lines of credit
  • Non-residents cannot refinance


Do non-residents need to be in Canada at any point to secure financing for a home?

Usually, non-residents will need to be in Canada at least twice to complete the process of financing and buying property.

First, a buyer will need to visit Canada to open a Canadian bank account. (Note, there are exceptions to this rule. For example, some of our clients have found that, as HSBC Premier clients, they’ve been able to open accounts in Canada from their home countries.

Second, non-residents must be present at closing, as there are no power of attorney options for closing.

What taxes do non-residents pay when purchasing real estate in Canada?

Non-residents are subject to the same land transfer taxes as Canadian residents when they purchase property here. Those buying residential property in or near Toronto will be required to pay Ontario’s Non-Resident Speculation Tax, which is 15 per cent of the purchase price.

Want to learn more?

Buying a home from another country can seem like an overwhelming prospect because there’s so much to learn. But we’re happy to explain the details. As licensed mortgage brokers, we work with home buyers and a wide array of major lenders to match people with the perfect mortgage for their needs. Our services are free to the home buyer.

 

Ready to dig deeper?
Go to our online application form so we can assess your specific mortgage needs.

blog, Mortgage Education

Top 5 Reasons to Work With a Mortgage Broker

Purchasing or refinancing your home can feel pretty daunting – but it doesn’t have to be when you have the right resources.

Steve Harrison, mortgage broker with Mortgages.ca breaks down the top 5 reasons why working with a mortgage broker can save your time AND your wallet!