Spring has arrived and we’re starting to get a better sense of the real estate market in Canada this year. Sales and listings have been on the decline, but we’re still seeing small price increases in parts of the country. This isn’t a huge surprise since sales are typically slow during the winter so we may see some movement in the near future.
Recognizing that affordability is still an issue for many first-time home buyers, the federal government proposed a $1.25-billion incentive program that would help finance five to ten per cent of a prospective buyer’s mortgage as part of a shared equity program as long as they have a minimum down payment for the home purchase. They also plan to increase the amount that first-time buyers can withdraw from their RRSPs, from $25,000 to $35,000, per individual.
This news may help new buyers, but there are many other factors that all potential buyers need to consider when they start looking for a home.
Fixed vs Variable rate mortgages
Studies going back to 1950 show that, in general, borrowers tend to save money when they choose a variable rate mortgage instead of a fixed rate mortgage. A five-year fixed rate mortgage – by far the most common mortgage term in Canada – typically comes with a higher interest rate than variable rate mortgages or shorter term fixed rate mortgages.
Fixed rate borrowers pay a premium for predictability, knowing their mortgage payments won’t be upset when the Bank of Canada hikes interest rates.
Variable or floating rate borrowers, on the other hand, will see their rates rise and fall whenever the prime rate moves. These borrowers are betting that interest rates won’t rise above the current fixed rate, or that rates rise much later in the mortgage term when they’ve already made significant savings on the spread.
The variable mortgage argument has been less compelling lately as the spread between fixed and variable rates narrows.
Take Equitable Bank’s current 5-year adjustable rate mortgage of 2.95% versus its 5-year fixed mortgage rate of 3.14%. The spread is just 19 basis points and so all it takes is the Bank of Canada to increase rates by 1/4 of a percent for variable rate borrowers to see their rate surpass the fixed rate.
A good rule of thumb to follow is when the spread between fixed and variable rates is less than 50 basis points, go ahead and lock-in the fixed rate. When the spread is closer to 75 or 100 basis points, the variable rate is more attractive.
Despite the historical data which many of your clients may be aware of, now is a good time to educate them about the current interest rate environment and how it affects them so they can pick a mortgage that fits their lifestyle.
Why a Credit Score is important for home ownership
Home buyers need a strong credit profile to access the best mortgage rates and terms. That starts with a solid credit score. Typically, a borrower with a credit score above 700 will qualify for the best mortgage options. It starts to get more difficult to qualify for the best rates and terms once your score dips below 680.
Lenders don’t focus solely on the credit score, however, as they’ll also examine payment history, outstanding debts, total debt load, number of open accounts, and the age of accounts.
Some of your clients might consider cancelling open credit cards or reducing credit limits, but that could be a mistake and can actually lower their credit score. Reducing the amount of credit you have access to lowers your credit utilization – a key component that makes up 30% of your credit score. Cancelling a credit card – especially an older card – reduces the average age of your accounts, and the credit bureaus prefer to see accounts with a long established history of credit use.
If your clients want to increase their credit score before buying a home, they could check their credit report for any errors, keep all credit accounts open, increase the credit limit on any existing accounts (to lower their overall utilization), pay off bills on time, and keep their credit balances at no more than 30% of available credit. They’ll also want to avoid applying for new credit, as an inquiry can lower their score temporarily by 10 points or so.
Picking a mortgage that works for your client in decreasing rate environment
Interest rates have been on the rise with five rate hikes between mid-2017 and last fall. But now, Bank of Canada Governor Stephen Poloz is signalling a slow down and has even left the door open for stimulative rate cuts.
Picking a mortgage in a decreasing rate environment can be equally as tricky as selecting one while rates are rising. Borrowers don’t want to leave money on the table by locking in to a higher rate, only to watch rates fall in the near term.
That’s where a shorter term mortgage can come in handy. While as many as two-thirds of borrowers choose a five-year fixed rate mortgage term, Canadians do have the option to select a one or two year mortgage term.
Possible advantages to selecting a short term fixed rate mortgage include that short term mortgage rates are typically lower than longer term rates. A short term also preserves the borrowers negotiating power rather than locking it in for five years. In a decreasing rate environment, the more opportunities one has to negotiate their rate, the more money they’ll typically save over the long term.
Imagine locking into a 1-year fixed rate mortgage at 2.99% when the 5-year rate is at 3.14%. If rates have fallen when it’s time to renew the following year, your clients may have the option to lock-in for five years at a lower rate, or continue to go with a shorter term as they ride the rate curve down even further.