Toronto Real Estate and Neighbourhoods Blog | Move Smartly

Five Questions For....Pascal Gauthier, TD Bank Senior Economist on the Real Estate Market in Canada and Toronto

John Pasalis in Toronto Real Estate News, Mortgages and Finance

Editor's Note: "Five Questions For" is a periodic series in which Move Smartly bloggers get answers to the questions we'd all like to ask about real estate.

TD Economics made headlines a few weeks ago when they released a report forecasting a 10% decline in Canadian home prices.  

I invited TD Bank Senior Economist Pascal Gauthier to answer five questions about the report they recently published and about Toronto's real estate market overall:

John Pasalis: Hi Pascal, thank you for taking some time to answer a few questions about the recent TD Economics report on Canada's real estate market.  Your colleague Grant Bishop calls for a roughly 10% decline in average home prices in Canada.  When do you see this happening?  Do you expect a quick decline in prices or is this going to carry into 2011?

Pascal Gauthier, TD Economics: The -10% mentioned by my colleague Grant is a peak-to-trough figure, rather than an annual average. Some of that adjustment is already under way on a (seasonally-adjusted) month-to-month basis, with average prices down about 3.5% since May. We think we are roughly a third of the way through the price adjustment, implying roughly another 9 months of trend decline – bottoming sometime in the first half of next year, likely Q2 on a quarterly basis.

John Pasalis: In May 2010, TD Economics released a report forecasting a roughly 5% total decline in home prices by the end of 2011.  What economic factors have changed over the past three months to account for the significant change in TD's forecast?

Pascal Gauthier: The May report referred to a -2.7% annual average national price change in 2011. As of August, this had been revised down slightly to -3.0% (see our latest housing tables, page 2)

John Pasalis: The strong recovery in the housing market in 2009 caught virtually everyone by surprise. What impact, if any, do you feel behavioral variables such as consumer perceptions and confidence have on the real estate market and how do you as an economist account for such variables?

Interest Rates: Why the Sky Isn't Falling

David Larock in Mortgages and Finance

Editor's Note: This week's post also appears in the September issue of REM magazine.

What a roller coaster ride the last two years have been. In the spring of 2009, Canadian house prices fell across the board and transactions slowed as fears of a global economic downturn spread. But then, as if only pausing for breath, Canada’s real estate market revved up once again and the spring dip looked like nothing more than a good buying opportunity. So why is everyone so nervous? When I talk to realtors, fears of rising interest rates are among the first concerns raised. There is a widespread assumption that rates can only go up, and a related belief that higher rates will hammer the real estate market. In fact, I don’t think either fear is warranted. Here’s why:

Short-term (Variable) Rates Aren’t Going Anywhere Fast Because… 

• The central bank’s primary reason for raising rates is to control inflation. Our inflation rate (as measured by the consumer price index) was at 1% as of July 23, 2010, well below the central bank’s upper limit of 2%.
• The effects of higher rates are felt only over time, so raising short-term interest rates gradually allows the central bank time to measure the impact of previous increases before tightening further.
• The real estate market is cooling off. One of the central bank’s main concerns with leaving its overnight rate at emergency low levels was that it would fuel a housing bubble. Today’s more balanced housing market has rendered that concern moot for the time being.
• While the Canadian economic recovery is in full swing, most of the rest of the world is not faring as well. In its recent commentary, our central bank has acknowledged that aggressive interest-rate hikes could stifle our momentum, especially against today’s backdrop of global economic uncertainty.
• The US Fed is not expected to increase its short-term policy rate until 2012 at the earliest. If our central bank keeps raising rates independently of the Fed, our dollar will continue to appreciate and this will slow our economy further. Most experts do not believe that Canadian short-term rates can be sustained at much more than 1% above comparable US rates (and we’re already .75% higher today).

Moderately Higher Rates Won’t Hammer the Real Estate Market Because… 

• Contrary to popular belief, there is no strong correlation between rising interest rates and lower house prices. In fact, historical data show that rates and house prices rise together more often than not. Before you say I’m out to lunch, let me elaborate. I readily accept that, all being equal, higher rates hurt affordability and are bad for the housing market.  But all is not equal.  Rising rates generally occur in an improving economy, and the positive economic momentum that accompanies higher rates creates a net effect that has historically proven more positive than negative. (I will elaborate on this point in next week's post.)

A Different View: Another Way to Value Your Home

Bruce Freedman in Mortgage and Finance

Editor's Note: "A Different View" is a periodic series in which guest bloggers are invited to share new and differing views on all things real estate.

For most Canadians, their home is by far their largest investment. That said, most new home buyers don’t actually do much in the way of valuation analysis to ascertain whether they should buy this largest investment. Instead they focus on “affordability” and the ever popular “hardwood floor-to-crown molding” ratio. Imagine if your broker used affordability as a reason to buy a stock.

Imagine this conversation:

Broker: “Ahhh. I just picked up 100,000 shares of Acme stock for you at five dollars.”

You: “Really? That’s $500,000! I’ve only got $50,000 in my account. And this stock has risen so much! What’s the valuation look like?”

Broker: “Huh? Valuation? What do you mean by this word “valuation?” I never heard such a question. The stock trades at five dollars. I bought your shares at five dollars. Five dollars is the valuation. Right now. But it’s going higher. The price has been rising for years and analysts, banks, politicians, property agents & taxi drivers expect it to continue to rise. Particularly if people like you continue to buy. Don’t worry about the price. I arranged a $450,000 loan for you to cover the difference. Don’t worry about the loan either. You and your wife earn good incomes and can afford the loan payments. Especially if we assume that interest rates remain at all-time lows — for the next 30-40 years.”

When an investor looks at an investment — any investment — as part of their due diligence, they should value it against its alternatives — both alternatives within the same industry and alternatives in other industries/asset classes. After all, greed knows no boundaries — it’ll eventually chase out the best returns.

The Mortgage Deal of the Week

David Larock in Mortgages and Finance

I love being an independent mortgage planner because I can offer my customers the best of what the wider mortgage market has to offer at any given point in time. Each morning I receive rate promotions and product updates from lenders across the country and sometimes, there are promotions and deals that jump off the page. “How”, I wondered, “can I keep readers apprised of the best deals going as part my ongoing advice and commentary?” After carefully considering different options, I decided to create a new link in the top right corner of my blog called “The Deal of the Week” which will give you a quick and easy way to see the best of what’s on offer. My first Deal of the Week will probably come as a surprise to my regular readers. Here’s why:

In today’s environment, I have advocated variable-rate financing as the best alternative for the majority of mortgage borrowers. Basically because with economic headwinds building at home and abroad, and inflation well under control, I think that the threat of dramatic rate increases is remote. My favourite plan of attack is for my variable-rate customers to use the money they save on interest to pay off their loan more quickly. One easy way they do this is by setting their regular mortgage payment at the equivalent fixed rate, because the excess portion of each payment goes straight to paying down principal. Having said that, I recognize that some borrowers are more conservative and don’t want to lose sleep worrying about volatility in the interest rate market. If you are part of the group that prefers the predictability of a fixed rate mortgage, then my inaugural Deal of the Week, should be right up your alley.

One of my lenders is now offering a three-year fixed-rate mortgage at 2.9% (which is well below the next best offer). Normally a deal this attractive comes with reduced features and flexibility (which are hidden costs) but in this case, the product comes with all of the standard bells and whistles. The only catch is that this is a limited time offer so if you want to take advantage of it, keep in mind that your transaction must close by October 15. Click here for full details.

With today’s prime rate at 2.75% and the average variable rate being offered at 2.10%, a fixed rate of 2.9% that is locked in for three years is a compelling alternative. If you're wondering if this offer is right for you, contact me and we'll take a look at your individual situation.

Lastly, I will update the Deal of the Week each Monday, so check back with us regularly to learn about other deals that are jumping off the page.

David Larock is an independent mortgage planner and industry insider specializing in helping clients purchase, refinance or renew their mortgages. David's posts appear weekly on this blog (movesmartly.com) and on his own blog (integratedmortgageplanners.com/blog). Email Dave

Reverse Mortgage Financing - Is it Right for You?

David Larock in Home Buying, Mortgages and Finance

One of the most common observations made about the financial profile of average baby boomers is that too much of their net worth is tied up in their primary residence. While real estate investments have served boomers well over their lifetimes, with steadily appreciating values and tax free capital gains, this asset class is also relatively illiquid and has a future that some fear may not be as bright as its past. Reverse mortgages offer Canadians over the age of sixty the opportunity to tap into their existing home equity without having to sell and move. The proceeds are tax free and the loan does not require any scheduled repayment. That said, a reverse mortgage is still an expensive way to borrow money and in many cases, is not the best option on the table when emotional factors like selling the family home are excluded. Today’s post will explain how reverse mortgages work and will outline the strengths and weaknesses of this option.

A reverse mortgage is simply a loan that is paid back with home equity, instead of with ongoing cash flow. To use a basic example, assume that you own a home worth $500,000 and that your lender advances you $200,000 on a reverse mortgage with a rate of 5.5%. Your annual interest cost (in simple terms) works out to $11,000, and this amount is added to your mortgage balance. So at the end of the first year, assuming no change in the value of your property, your mortgage will increase to $211,000 and your equity will decrease to $289,000. Homeowners (and spouses) must be at least sixty years of age and the maximum amount of home equity that can be withdrawn is set on a sliding scale according to age (60 yrs = 25%, 70 yrs = 40%, 80 yrs = 55%). Reverse mortgages are available in most urban areas and are offered on most standard property types (house, townhouse, condo etc.), provided that the home being mortgaged is the borrower’s primary residence. These loans can be paid off at any time, although there are stiff penalties if you break your mortgage in the first two years of the contract.

The vast majority of Canadian reverse mortgage transactions have been funded under the Canadian Home Income Plan (CHIP) brand, which has been around for 25 years and is now part of HomEquity Bank, a newly minted Schedule I Canadian bank. There is finally a bit of competition from smaller players, for example, Seniors Money Canada, and this has corresponded with more reasonable interest rate charges. CHIP’s average loan amount is 35% of the property’s value, and CHIP states that “on average, the amount left over is more than 50% of the value of the home when it is [eventually] sold.” While a little surprising, this statistic is mostly a result of the steady increase in Canadian home prices over the past 25 years. (For illustrative purposes, we will now evaluate CHIP’s offering, since they are the dominant Canadian competitor.)

Summer Mortgage Market Update

David Larock in Mortgage and Finance

Any attempt to forecast the direction of Canada’s interest rates in today’s environment must weigh the strength of our domestic economy against headwinds blowing from both the US and China. While the Canadian economy chugs along, China’s is sending mixed signals and the US economy continues to slow. The health of these two economic super powers will significantly influence our own economic momentum, and as such, the key question is: how will our central bank reconcile these competing internal and external forces when formulating our interest rate policy? It’s a tough call. Edging rates higher gives Mr. Carney more flexibility to provide future monetary stimulus, but it also slows our delicate recovery, which is still far from assured against a backdrop of global economic uncertainty.

First, a recap. In our Spring Mortgage Market Update, we tried to talk people off the ledge, predicting that interest rates would not go to the moon despite the ominous forecasts of most bank economists. Since that time, these same economists have revised their predictions of interest-rate increases downwards, citing the same factors that we used to refute their original predictions. Being wrong didn’t hurt the banks at all mind you. Far from it in fact, since the customers that heeded the bank’s dire warnings converted to their much more profitable fixed-rate mortgages (I guess having the bully pulpit has its advantages). What a shame for customers who locked in at 4.4% when five-year fixed-rate mortgages have come down to 3.9% since that time.   

In the US, where 85% of our exports are sold, the summer winds have brought fears of a double-dip recession and increasing concerns over the threat of deflation. The US Fed’s policy rate has been at zero percent since December 2008, and rather than increasing spending, this emergency level stimulus has corresponded with increased savings and reduced lending, creating ideal conditions for a potential liquidity trap. While some may think that talk of a US liquidity trap is still premature, the situation bears watching. For example, a comparison between the factors that led to Japan’s liquidity trap (the best and most recent example) and the factors now present in the US shows many similarities: property and credit bubbles bursting, a large transfer of debt from the private to the public sector including government support for companies that would otherwise fail, consumers and businesses saving instead of spending, interest rate levels too low to provide additional stimulus and the inability of quantitative easing (printing money) to create inflation. Given the importance of the US as our main export market, we will be seriously impacted if they are hit with a deflationary spiral induced by a liquidity trap.

Interest Rates and The Liquidity Trap

David Larock in Mortgage and Finance

Falling interest rates are usually met by borrowers with a toast all round. After all, what other substantial cost do we have that has the potential to decrease over time? Consumers and businesses alike can use this found money to pay down debt faster, to reinvest, or to spend. But the decision they make about what to do with this extra money has far-reaching implications for the overall economy because while reinvesting or spending the money contributes to economic growth, saving it or paying down debt has the opposite effect. With thousands of people making the decisions to save/spend on a daily basis, our economy’s momentum is in constant flux and our central bank uses short-term interest rate adjustments to keep it from becoming too hot or too cold. This ability to adjust short-term interest rates is our central bank’s main policy instrument, and it is a powerful tool until the overnight rate approaches zero. When this happens, the ability to stimulate growth by lowering rates is lost, and threat of a liquidity trap emerges. Today’s post will explain how a liquidity trap is caused and may well change your reaction the next time Mr. Carney inches the overnight rate upwards.

Let’s start by outlining the circumstances under which our central bank would lower the overnight rate to zero percent. Such an emergency measure is required when spending and business investment plummet because with less money circulating, the economy slows dramatically. The central bank tries to offset this negative momentum by lowering policy rates, making saving less attractive and borrowing more so (in effect by penalizing savers and rewarding borrowers). If the stimulus works, spending and investment increases, and the economy recovers. But it’s a gamble. Like an engine that is flooded with gas from too much priming, very low rates can instead stall the economy if consumers and business don’t respond to these incentives and decide to save instead of spend. This is the liquidity trap - policy rates at or near zero causing increased savings instead of increased spending.

The RRSP Homebuyers Plan: An Excellent Way to Save for the Down Payment on Your First Home

Jesse Merson in Home Buying, Mortgages and Finance

Let's face it, saving money for the down payment on your first home can be an overwhelming task. These days, you are required to put down a minimum of 5% of the purchase price of your first home, the minimum that mortgage insurers CMHC or Genworth will allow.

If you are looking at buying a home for $300,000, you will need a minimum down payment of $15,000. Buying a home for $500,000? You will need a minimum down payment of $25,000, and so on.

When I meet with first time home buyers, more often than not we have a thorough discussion around the federal Home Buyers Plan. There seems to be a few misconceptions out there when it comes to the details of the plan and how it actually works. The Home Buyers Plan is an excellent way to get a "boost" from your current savings or to help you get started saving towards your down payment.

What is the Home Buyers Plan? It is a government program that lets you withdraw money from your RRSP savings (even if you don't have any), towards the down payment on your first home, tax free and without paying a penalty. You can also use the Home Buyers Plan to help a relative with a disability buy a home.

 

If you fall into either of the following scenarios, you may be able to take advantage of the Home Buyers Plan and benefit from significant tax breaks:

• You do not have enough money for a down payment, but have money in a Registered Retirement Savings Plan (RRSP).
• You have money for a down payment and have unused RRSP contribution room.

Mortgage Financing for Vacation Properties and Second Homes

David Larock in Home Buying, Mortgages and Finance

Happy belated Canada Day! This past weekend as I wound my way north up to cottage country, I was thinking of ideas for this week’s post (taking the 400 out of Toronto on a long weekend gives you plenty of time to do this). My first inclination was to write about the new HST changes impacting mortgages and lending, but since partnering with a mortgage planner doesn’t cost you anything (in tax or otherwise) it seemed too short for a post. Instead, given the fabulous weather we enjoyed across southwestern Ontario this past weekend, I thought it would be a good time to write about mortgage financing for vacation properties and second homes.

First let’s explain the difference between these two property types. A vacation property is for recreational use and can come in many forms: cottage, ski chalet, cabin etc. A second home is used more traditionally, for example, as a pied-à-terre for long commuters and retirees, or as a university residence for children who would otherwise rent. In both cases, lenders assume that the buyers of the property will either use it themselves, or allow it to be used by family members on a rent-free basis (if the property is being used to derive income then it is classified as a rental and a different set of rules apply). While you’ve probably seen both terms, maybe with a different-coloured pamphlet for each, in reality you’ll find that vacation properties and second homes are treated the same by lenders and insurers alike. (For that reason, from now on I’ll just refer to them as second homes).

Closing Costs – The Stomach Punch of the Home Buying Process

David Larock in Home Buying, Mortgages and Finance

Estimating your closing costs after the excitement of buying your home is about as appealing as sorting out travel insurance after you’ve booked your dream vacation. That said, closing costs are unavoidable (unless you know something I don’t) so the best approach is to prepare for them ahead of time. The old rule of thumb for closing costs was to conservatively assume that they would account for approximately 2% of your purchase price but with Toronto’s new land transfer tax and HST being applied to new home purchases, that approach is somewhat dated. [Shameless plug alert] Thanks to the wonders of technology and the help of a programmer in India who converted my homemade Excel spreadsheet to JavaScript, you can now use our one-of-a-kind calculator to get a very accurate estimate of what your closing costs, including rebates, will be (it even has a demo). Today’s post will give you a brief explanation of closing costs and then I’ll close with a couple of insights that I think every home buyer should hear.