New Mortgage Regulations in Effect.......

Poof...just like that and it’s harder to qualify for a mortgage or at least you’ll qualify for less than you would have a week ago. The new government regulations have completely gone into effect as of today. Here is a brief snapshot of what they look like:

• All borrowers must meet the standards for a five-year fixed-rate mortgage even if they choose a mortgage with a lower interest rate or a shorter term. This is meant Canadians prepare for higher interest rates in the future.
• Lower maximum amount Canadians can withdraw when refinancing their mortgages to 90% from 95% of the value of their homes. This will help ensure home ownership is a more effective way to save.
• Require a minimum down payment of 20% for government-backed mortgage insurance on non-owner-occupied properties purchased for speculation (investment properties).

Another change that went into effect on April 9th that didn’t get much attention:

• Self-employed borrowers are now limited to borrowing 90% of the value of their homes and can only have been in business for less than 3 years to in order to qualify for CMHC’s self-employed program.

I won’t get into how limiting the self-employed changes for small-business owners will be. It wasn’t like the old rules made it all that easy. The change I’m still most curious about is the change in qualification criteria (1st point above). The jist of it is that if you take out a five-year fixed mortgage, you qualify at the rate you’ll be paying, which currently is in around 4.49%. If you take a variable mortgage or a fixed mortgage of less than five years you qualify at the Bank of Canada 5-yr rate, currently at 5.85%...soon to be 6.10% on Wednesday. So, if you’re looking at a variable mortgage that’s charging 1.75% right now, you need to qualify at 6.10%. That means your income needs to be approximately 25% more than it did last week in order to qualify for the same mortgage or, where a family earning $90,000/year would have qualified for a mortgage of $350,000, they will now only qualify for a mortgage of $265,000. However, if they choose a five-year fixed mortgage, they will qualify for $310,000. What this means is for a lot of people, not all, an element of choice has been taken away. Where people were starting to see that there was more out there than five-year fixed mortgages, we’re now going to back to that being by far the most popular choice. Is it a coincidence that the five-year fixed just happens to be the most profitable product for the banks? Is it also a coincidence that the leaders of our banks have closed-door meetings with the Minister of Finance and the Bank of Canada? I’ll let you decide. You can probably guess what I think.

There is a slight bit of silver lining. The above changes are for high-ratio (greater than 80% loan-to-value) mortgages, although the banks have implemented the changes to their conventional mortgages (less than 80% loan-to-value). However, some lenders in the broker market are still following the old rules of qualification for conventional mortgages. So, for those of you with less than an 80% loan-to-value, you still have some choice if you go through a broker but if you still deal with a bank, you’re more than likely going to be jammed into a five-year fixed mortgage.

The ironic part is that the government thinks that what they're doing will help consumers by ensuring that if rates go up, they will still be able to afford their payments, lowering the level of default. However, what they are also doing is creating the bubble that they claim to be trying to protect us against since homebuyers won't be able to qualify for as much, which will eventually drive down the cost of real estate.

Fixed Rates Increase and Create the Biggest Fixed-Prime Spread in 30 Years

Well, the smoke has finally cleared after the fixed rate increases from last week. The biggest single-day jump in fixed rates in 14 years created record volumes at lenders as borrowers rushed to get applications and pre-approvals in before the hikes took effect. What also resulted from the increase is the biggest Fixed-Prime spread in 30 years. The spread (difference) between discounted 5-year fixed and 5-year variable mortgage rates is currently about 240 basis points.

Based on estimates (there is no record of historical pricing on discounted fixed and variable rates), that is one of the biggest spreads in a very long time. The only historical data that is kept is the between the posted 5-year fixed rate to prime rate, the spread between the two right now is 360 bps.

That’s the biggest spread in the last 30 years (based on monthly data from the Bank of Canada).

Technically, today’s posted Fixed-Prime spread is tied with the 360 bps reading we saw last summer. The difference is that variable rate discounts last summer were nowhere near the P - 0.50% we have today.

To put it another way, today's plump Fixed-Prime spread indicates what many already know: fixed rates are selling for a major premium over riskier variable rates...or is it that variables are selling at an extremely deep discount? It is likely the spread will close when the Bank of Canada starts increasing its Overnight Rate early in the summer as is widely anticipated. Some analysts are expecting the Overnight Rate to increase from 0.25% now, to 1.25% by the end of the year. Even with that “big” of an increase, variable rates still stand to be below 3% compared to the discounted 4.35% 5-yr fixed rates that are available now.

This is meant to be some food for thought rather than predictive but consider this; if you look back to 1980 for cases where there’s been a 2%+ fixed-prime spread, prime rate has never averaged more than 1.75% higher in the five years that followed.

Will 2010-2015 be the first such instance? Time will tell. But one thing’s for certain, today’s fixed rates are trading with a huge built-in “insurance premium,” and the 2.40 percentage point edge gives variables a big head start as we move into the next rate hike cycle.