What the Rate Cut Means for Mortgages
What the rate cut means for mortgages
Garry Marr, Financial Post
The latest rate cut means consumers buying a house can borrow for as little as 3% interest on their loan if they are willing to buy into the Bank of Canada's statement Tuesday that it won't be changing rates until June, 2010.
If you don't believe the bank will hold steady on its promise, you can lock into five-year, fixed-rate mortgages for as low as 3.85% on a discounted basis -- the lowest rate in Canadian history.
But all of that may amount to nothing when it comes to soothing a Canadian housing market in which new construction has fallen below 200,000 on an annualized basis for the first time in seven years. March existing-home sales were off 13.7% from a year ago.
"What is 25 basis points among friends? It's really nothing," said Benjamin Tal, senior economist with CIBC World Markets. "This is not something that is going to change the course of the market. It only helps at the margin."
Mr. Tal did say mortgage refinancings have risen dramatically in the past few months as Canadians who might have borrowed at 5.75% just over two years ago are ready to eat any interest rate penalty because a five-year rate mortgage is now so low.
The penalty to break an existing mortgage is the greater of three months interest or what is called the interest rate differential. The interest rate differential is the lost interest between your current rate and market rates.
Mr. Tal says while there is not much lower for variable-rate mortgages to go, the gap between short-term money and long-term money is still significant enough that the temptation is not to lock in.
"You might do better the first two years [of a five-year mortgage] but not the remaining three. I'm convinced long-term interest rates will rise. I can see [long-term] rising 200 basis points. These are emergency rates and at some point this emergency will end," says the economist.
John Turner, the director of mortgages at the Bank of Montreal says he's never seen anything like what is going on in today's market.
"There is a possibility of another drop," says Mr. Turner. "But does your tummy feel good about something that has a higher possibility of going up than going down any further."
He is convinced these lower rates will boost the housing market. The 13.7% decline in home sales in March was the smallest year over year decline in six months. "I think there is a segment of the market that couldn't afford a home before," said Mr. Turner.
Don Lawby, chief executive of Century 21 Canada, said while rates are declining, banks are getting tighter with how they hand out credit.
"If you are self-employed, the banks are demanding more documentation. Appraisals are getting harder too. It's not what you bought the house for but what it's appraised for," said Mr. Lawby, who also heads up a mortgage broker business. "There is not a lot of subprime out there for people with any credit problems in their history."
Quantitative easing Q&A with the BoC
FP Posted: April 21, 2009, 10:16 PM by Alia McMullen
With interest rates now at a record low 0.25%, the Bank of Canada has provided definitions of quantitative easing and credit easing on its website.
What happens when the policy interest rate approaches zero?
"The traditional monetary policy instrument used by central banks to stabilize the economy and maintain price stability is the policy interest rate. When the policy rate moves towards zero, a central bank may consider using other tools to provide stimulus to the economy and achieve its inflation objective. This can include consideration of so-called 'unconventional' monetary measures such as quantitative easing and credit easing."
What is quantitative easing?
"Quantitative easing is the purchase by a central bank of financial assets through creation of central bank reserves. As a result, the price of the purchased assets (which can include government securities or private assets) rises and the yield on the assets falls. The expansion of reserves available to commercial banks also encourages them to increase the supply of credit to households and businesses.
In economic terminology, quantitative easing uses 'unsterilized' funding; in other words, the reserves of the central bank are increased to finance asset purchases."
What is credit easing?
"Credit easing is the targeted purchase by a central bank of private sector assets in certain credit markets which are important to the functioning of the financial system. The goal of credit easing is to reduce risk premiums and improve liquidity and trading activity in specific markets so that credit will flow and demand in the economy will expand.
Credit easing can be done on a 'sterilized' basis; in other words, there is no need to increase central bank reserves in order to undertake credit easing. If undertaken on an unsterilized basis, this amounts to combining credit easing with quantitative easing."
