6 Oct

Important Changes to Mortgages – October 2016 – part 2

General

Posted by: Gleb Tchani

Hello Everyone,

               I am sure by now most of you have heard that there are a number of changes coming to mortgage industry and I would like to give you a quick overview.  Over the last few years, there have been a few minor changes.  The new changes, however, will certainly have a much stronger impact on the real estate market.  The changes are aimed to achieve different goals.  The major areas of concerns were: household debt levels in Canada, foreign speculative buyers, soaring real estate prices and federal government’s (tax-payers’) risk exposure in current environment.  Here is the information we have at this point on some of the major changes to be implemented:

 

Stress Test

This will probably have the biggest impact on real estate market.  Here is what it is and how it affects us.  Every time we apply for a mortgage we go through an income qualification process.  This process uses the ratio of household income in relation to debt.  The debt portion of this ratio uses expenses associated with owning a property.  Until now, for qualification purposes, the mortgage expense on 5-year, fixed mortgages used a rate that was offered to you in the contract.  This rate is in the range of 2.29% to 2.79%.  Variable rate mortgages, as well as mortgages on shorter terms used a Bank of Canada posted rate for the same qualification.  As of September 28, 2016, the Bank of Canada posted rate was 4.64%.  The new change will require qualification for all mortgages with less than 20% down payment to be done using the higher of, Bank of Canada posted rate or the contract rate.  In most cases the Bank of Canada posted rate of 4.64% will be the higher of the two.

Scenario 1 – A household with an annual income of $60,000, no other debt, 5% down payment, an estimated property tax of 1% and a 25-year amortization.

Now (prior to change) will qualify for approximately $370,000 property value.

As of October 17th, 2016, the same household would only qualify for about $300,000 property value.

Or, the same household would need approximately $73,000 annual income to qualify for the original $370,000

Scenario 2 – A household with an annual income of $100,000, no other debt, 5% down payment and estimated property tax of 1%.

Now (prior to change) will qualify for approximately $630,000 property value.

As of October 17th, 2016, the same household would only qualify for about $510,000 property value.

Or, the same household would need approximately $125,000 annual income to qualify for the original $630,000

The effect of this particular change will likely be the most noticeable.  The above scenarios indicate that, for many buyers, the overall buying power for real estate will likely decrease by approximately 20%.  Unfortunately, I do not have the resources to tell you how much of an effect that will have on real estate prices but, based on the simple observation above, we could see a decrease in real estate prices by as much as 10%.

Primary Residence Tax Exemption

This change is mostly targeted at foreign buyers but it will likely have an effect on people owning more than one property.  Up until now, anyone who sold their principal residence in Canada did not have to report that sale to the CRA, or the profit earned on that sale, because this profit would qualify for a tax exemption.  From now on, the federal government will require sale of every property to be reported to CRA.  This means that now, CRA will be closer monitoring such transactions and people that file taxes in Canada will have to prove that the property qualifies for principal residence exemption.  There are other loopholes that foreign investors can use so this change will not likely have as big of an overall impact as intended but people owning more than one property will have to be extra cautious.

Mortgage Insurance Changes

This measure is introduced to reduce risk to tax payers associated specifically with mortgaging properties of higher value ($1,000,000 and over).  As of November 30th, the government will impose extra restrictions on when insurance will be provided for low-ratio mortgages (down payment higher than 20%).  Here are the four new restrictions:

  1. Property must be owner-occupied,
  2. Amortization period must be 25 years or less,
  3. The purchase price has to be $1,000,000 or less, and
  4. The buyer has to have a credit score of 600 or higher.

Possible Changes to Risk Sharing

This change is also introduced to lower governments exposure to risks associated with possible wide spread defaults on mortgages.  Currently, the federal government is responsible for practically 100 percent of insured mortgages, in the event they default.  The government will be reviewing the market and possibly implementing measures where some of the risk is taken on by the lenders.  With today’s low rates, most of the extra costs associated with mortgages are transferred onto a borrower, us.  If the mortgage lenders are forced to take on the added risk, it could potentially lead to higher mortgage rates.

 

At this point, it is hard to forecast the actual outcome of these regulatory changes and there is no doubt that they will be disruptive in the short term.  I am committed to providing my expertise and helping my clients navigate through these changes.  If you have any questions, please fee free to contact me to review your situation.

 

Sincerely,
Gleb Tchani 

4 Oct

Important Changes to Mortgages – October 2016

General

Posted by: Gleb Tchani

Hello everyone,

               Some of you may have heard that yesterday, Ottawa unveiled a major initiative to slow down housing market.  There are a few changes and I will provide more detail on it.  For now, I want to highlight one of the changes that is coming into effect October 17th, 2016, that will likely have the biggest effect on the market.  It is referred to as a “Stress Test” and is designed to ensure Canadians can still afford their mortgage payments, should the rates increase.

               Every time we apply for a mortgage we go through an income qualification process.  This process uses the ratio of household income in relation to debt.  The debt portion of this ratio uses expenses associated with owning a property.  Until now, the mortgage expense on 5-year, fixed mortgages used a rate that was offered to you in the contract.  This rate is in the range of 2.29% to 2.79%.  Variable rate mortgages, as well as mortgages on shorter terms used a Bank of Canada posted rate.  As of September 28, 2016, the Bank of Canada posted rate was 4.64%.  The new change will require qualification for all mortgages with less than 20% down payment to be done using the higher of, Bank of Canada posted rate or the contract rate.  Here is an example of how it effects the qualification:

Scenario:  A person with an annual income of $60,000, no other debt, 5% down payment and an estimated property tax of 1%.

  • Now will qualify for approximately $370,000 property.
  • As of October 17th, 2016, the same person would only qualify for about $300,000 property.
  • Or, the same person would need approximately $73,000 annual income to qualify for the original $370,000

It should be fairly easy to understand how this will affect the market.  The affordable price of a property will now see a significant decrease.  The example above is on a fairly low-valued property.  The affects will be noticeably more significant on the properties over $500,000.

The other changes coming into effect are targeted more towards foreign investors and I will have a separate article that will cover all major items.

4 Mar

Understanding Mortgage Penalties

General

Posted by: Gleb Tchani

     One major concern we address when entering a mortgage contract are the penalties.  We have all heard about people having to pay $10,000 or $15,000 in penalties.  Some times, the lender will offer you a discount if you start another mortgage with them, some times they will offer you to put it into your new mortgage, some times you just have to pay.  The bottom line with all of these alternative is that, you are potentially losing a substantial amount of money yet no one really prepares you for it when you look over the contract.  We all know that there are two types of interest rates: variable and fixed.  I will try to give you a better understanding of what you may potentially have to deal with.

     The penalty calculations of a variable rate mortgage are straight forward; it is three months interest.  For example: with an outstanding balance of $300,000 and a mortgage rate of 2.5%, you simply multiply annual rate by the remaining balance and divide it by 4 to come to a 3 months interest.  $300,000 x 2.5% ÷ 4 = $1,875.00.

     Things get a little more complicated when we have fixed rate.  To avoid confusion, I will try to go into as little detail as possible but there is still a lot of important factors.  I really think, between the links and the explanations, it will be worth a couple extra minutes of your time to stick through the whole article.  A small note here; most of us do or, will end up obtaining a fixed rate mortgage as it is much easier to qualify for.  I will have another article dedicated to the qualification process.  Here is the typical contract penalty description for a fixed mortgage.

 

The Early Payout Penalty is equal to the greater of 3 months simple interest or the Interest Rate Differential Amount:

  • 3 months simple interest. This is calculated by applying your current Interest Rate being charged on your Mortgage to the outstanding Principal balance of your Mortgage, for a 3 month period.
  • Interest Rate Differential Amount. This is calculated by applying the difference between:

a)     The Interest Rate being charged on your Mortgage, and

b)     The current best rate in effect at the time, being charged by us on a loan with a term that is closest to the remaining term of your Mortgage.

This rate difference (between a and b) is then applied to the outstanding principal balance of your Mortgage, for the remaining term of your Mortgage.

 

     What really becomes a problem is that the Interest Rate Differential (IRD), while under the same name, is a different formula from lender to lender.  In this above example, the explanation of IRD is actually what it logically should be with every institution.  Unfortunately, as you will see below, that is not the case.

     To show you the difference, I have taken 5 major banks and 2 lenders that I like to deal with and reviewed their penalty calculators.  I applied the same scenario to each calculator and tried to find or derive the (IRD) formula they use.  With a few institutions, I was not able to find or explain the calculations so I just used the answer from their online calculator.  For each institution I provided a link to their mortgage penalty calculator.  For each scenario, I assumed a remaining term of 3 years of the original 5-year mortgage and a remaining balance of $300,000

     Let’s start with major banks.  When selling mortgage products, all 5 major banks use a strategy of posted rate and a discount.  Other lenders use this concept as well, but usually only for qualification purpose.  When you walk into any of the big 5 banks, you will see their posted rates.  You can also find them on their respective websites: RBC, BMO, CIBC, Scotia, TD.  From that rate, you get a “discount” and come up to a discounted rate, some banks have that specified right there, on the same page with posted rates (side note: the discounted rates, are usually still above what’s available in the market).  That discount you receive is one of the factors that affects your mortgage penalty when it comes to that point.  In fact, as you can see from information I provided below, the higher the discount, the higher penalties you can expect.  I could only confirm it for CIBC, Scotia and TD but I have a feeling RBC and BMO also have rate discount incorporated into their formula.

     The other 2 lenders I have included are MCAP and First National.  The example description I have used above is from an actual MCAP commitment.  As penalties are probably the next most important shopping factor after the actual rate, I like to chose lenders that have a reasonable and a clear explanation of their IRD calculations.

     As you can see below, the highest penalty came out to be $11,438.68 by BMO.  Out of the 5 major banks, RBC had the lowest penalty at $7,713.39 and First national had the lowest penalty of all at $4,112.37.  4 out of 5 major banks came out with a number above $10,000. 

     As I mentioned, the reasonable number should be what we see calculated by MCAP, $5,400.  You can see the calculation below, and, it matches the description given in the example above and, the $5,400 is almost half of what you would pay at most major banks.

RBC

  • Penalty Calculator: Link
  • Penalty amount using online penalty calculator provided by the lender:  $7,713.39
  • Formula:  Could not be located

BMO

  • Penalty Calculator: Link
  • Penalty amount using online penalty calculator provided by the lender:  $11,438.68
  • Formula:  Could not be located

CIBC

  • Penalty Calculator: Link
  • Penalty amount using online penalty calculator provided by the lender:  $11,250.00
  • Formula: 

Scotia

  • Penalty Calculator: Link
  • Penalty amount using online penalty calculator provided by the lender:  $11,250.00
  • Formula: 

TD

  • Penalty Calculator: Link
  • Penalty amount using online penalty calculator provided by the lender:  $11,250.00
  • Formula: 

MCAP

  • Penalty Calculator: Link
  • Penalty amount using online penalty calculator provided by the lender:  $5,400.00
  • Formula: 

First National

  • Penalty Calculator: Link
  • Penalty amount using online penalty calculator provided by the lender:  $4,112.37
  • Formula:  Could not be located
Have any more questions?  Do not hesitate to contact me, I would be very happy to help.
29 Feb

Fixed, Variable, Closed, Open

General

Posted by: Gleb Tchani

Many of you may be aware of the differences, but I often come across this confusion, so I would like to clarify on what each of these mean.  Fixed and Variable are conditions that describe the interest rate on the mortgage, while Closed and Open describe the type of contract you are entering.  Also, I will add a quick note on what is a Term and what is an Amortization.

Variable Rate – this is a form of a mortgage interest rate that is determined by the Prime Rate, which in turn is set, based on the Overnight Lending Rate set by the Bank of Canada.  The Overnight Lending Rate is a government tool that is reviewed on quarterly bases to move toward a specified economic goal.  You can find more information, including future meeting dates, on the Bank of Canada website at the following link.  A change in Overnight Lending Rate, typically, triggers change in Prime Rate and, since there is a potential of change at any given quarter, the said rate is referred to as variable.

Example:

Today, February of 2016, you are able to obtain a Prime – 0.55%.  Current Overnight Lending Rate is 0.50% and current Prime Rate is 2.70% so the rate you are able to obtain is Prime – 0.55% = 2.70% – 0.55% = 2.15%.  Next Bank of Canada meeting for interest rate announcement is set at March 9th.  Let’s assume the overnight lending rate gets increased by 0.25% to 0.75%.  This move will likely be followed by banks increasing their Prime rate by the same increment of 0.25% to 2.95%.  The new Prime Rate will change your contract rate to Prime – 0.55% = 2.95% – 0.55% = 2.40%.

 

Fixed Rate – this rate remains fixed through the duration (term) of your contract.  No matter what happens with the economy and/or the market, you will continue your mortgage contract with the specified rate.  We all understand that, in the long run, it is more likely that the rates will increase.  Fixed mortgage rates offer us, the clients, a peace of mind.  For that reason, lenders will typically offer a slightly higher fixed rate over the variable rate.

Closed Term Mortgage – closed term mortgages are mortgage contracts where we are locked in to all conditions of the contract for the term of the contract.  One of these conditions is inability to repay the mortgage ahead of time.  This is important to the lenders because their income is determined by us, clients, continuing to hold a mortgage loan and hence, paying interest.  Because this feature is beneficial to the lender, we as clients are able to obtain a better rate that way.  Mortgage penalty is a very important issue that often comes up and is a result of breaking a closed term mortgage.  This details of mortgage penalties require a separate article that I will get to in the near future.

Open Term Mortgage – on the other hand, an open term mortgage allows us to repay full balance at any time.  Early prepayment actually has a negative impact on the lender as they are expecting us to pay interest over a certain period of time.  Since it is not beneficial to the lender, the open term mortgages rates are usually higher.

Term vs Amortization – both of these describe length of time and just to help you avoid confusion, Term is the length of current contract, where Amortization is the total amount of time it would take to repay a mortgage.  The length of amortization is one of the factors that determines amount of your payments.  That is why, even though you may be signing a contract for just 5 years, it is important to know what the amortization period is.  At the end of the term, you have an option to repay the remaining balance or make another arrangement for a mortgage loan.  If you do not refinance and simply switch to another lender, you now have a new mortgage contract for a new term, but with only the remainder of your amortization period.

Have any more questions?  Do not hesitate to contact me, I would be very happy to help.

26 Feb

What is an RRSP Loan and how can it help me with down payment?

General

Posted by: Gleb Tchani

I would like to present you with a brief overview on what is an RRSP loan and how it can help a first time buyer using Home Buyers’ Plan (HBP).  This article is not about how to incorporate RRSP into your retirement planning.

 What is an RRSP loan?

               RRSP loan is a loan that is given out for a sole purpose of contributing to an RRSP.  Putting those funds into an RRSP program is basically a requirement.  For that reason, these loans often come with a lower interest than regular personal loans.  For example, Manulife Bank currently offers Prime + 0.5% or 3.2% on the RRSP loan.

Where can I get an RRSP loan?

               The RRSP loans can be obtained through practically any financial institution.  I am able to assist with obtaining such loan through Manulife Bank.  Manulife Bank offers many benefits and flexibility.  Please contact me for more information.

How can RRSP loan help a first time home buyer?

               As you may know, Canadian Government allows First Time Home Buyers to withdraw as much as $25,000 per individual to assist with a purchase of their first property.  This program is usually referred to as Home Buyers’ Plan.  Here is a link to CRA webpage for reference.  The major requirements to qualify for this program are; to be a first time home buyer and, to have RRSP funds in the account for a minimum of 90 days prior to a withdrawal under the Home Buyers’ Plan.

               We are all aware that putting money into an RRSP triggers a tax refund.  For people with an income of between $45,000 and $90,000 the refund should be around 30% of the contribution amount.  Let me use a scenario to explain how it works:

John Doe has an annual income of $80,000, has $25,000 in savings but wants to have another $15,000 to bring his down payment to 10% on a $400,000 purchase.  If John borrows a $15,000 RRSP loan for a term of 2 years and a rate of 3.2%, his monthly payments will be $646.05.  If John simply makes his monthly payments for next two years, total amount of interest he would pay would be $505.10.  However, John will receive back a tax refund that would be approximately $5,000.  If John uses this amount to pay off a portion of his debt, the remaining balance will be $10,000 (Manulife Bank’s RRSP loan is an open loan and can be repaid at any time).  Now, John’s remaining repayment period is only a year and 4 months and total interest paid over that period would be $225.98.  Alternatively, John could simply use that extra $5,000 to help him with closing costs.  It takes a few days to process the loan and deposit into an RRSP account and the extra $15,000 can be used in 90 days.

When do I have to repay the amount used under the HBP?

               The repayment can be postponed for 2 years and then a minimum of 1/15th of the borrowed amount has to be re-paid each year for next 15 years.  Alternatively, the 1/15th can be simply added to that year’s income and you would just pay tax on it.  Since you are technically borrowing from your self, there is no interest on the amount used under Home Buyer’s Plan.

Some FAQs

  • – When you withdraw money from an RRSP using HBP, you get a cheque (or transfer into your account).  Often people are under the impression that the money has to go into down payment.  That is not true, the money can be used for anything, literally.
  • – The money can be withdrawn from RRSP using Home Buyer’s Plan between 30 days before and 30 days after the closing date.

Have any more questions?  Do not hesitate to contact me, I would be very happy to help.