Category: Mortgage Information

This article appeared in the Globe and Mail on November 11th, 2012 and was written by Robert McLister.

Just a few decades back, many thought it unthinkable to still be paying a mortgage during retirement. But a growing minority are now doing just that.

Whereas our parents paid off their mortgage in roughly 12 years on average, about one in four homeowners are now carrying a mortgage into retirement. In fact, retirees are accumulating debt at three times the average pace.

Aversion to debt has clearly waned. Almost one-quarter of baby boomers say paying off their mortgage by retirement is “not very important” or “not at all important.” And more than half of Canadians expect to carry a mortgage into their golden years.

“My philosophy is to not carry any debt into retirement,” says retirement expert Gordon Pape. “But people today have a very casual attitude about it.”

So, just how big of a problem are mortgages in retirement? After all, places like Switzerland – which rivals Canada for the world’s strongest banking system – have 100-year “generational” mortgages. (What a way to get back at your kids!) And in a number of other prosperous European countries, interest-only mortgages – with theoretically infinite amortizations – are commonplace.

The threat posed by having a mortgage in retirement depends, not surprisingly, on the borrower’s income, savings, debt and other living expenses.

Statistically speaking, if you’re a typical married couple over 65, the latest government figures show that you take home about $46,000 combined each year. The median retiree’s mortgage is about $87,000. That implies a $411 monthly payment on a standard five-year fixed rate mortgage. That’s about 11 per cent of the typical retiree’s after-tax income, something that is easily tolerable.

On average, mortgages in retirement aren’t sending people to the poor house. Where it could get dicey, Mr. Pape says, is when interest rates rise. For a sizable minority without financial breathing room, “There is potential for real trouble down the road.”

For many single or lower income seniors, carrying a mortgage can be like walking in a minefield. All it takes is one misstep or personal crisis to explode your budget and fall behind on debt payments.

A couple relying 100 per cent on Old Age Security, for example, will earn a maximum of $26,800 annually in Ontario. In this case, that “typical” $411 mortgage payment would account for 18 per cent of their income. While unlikely anytime soon, a three percentage point interest rate hike would bump that to 25 per cent. Then you have to add in the property taxes, maintenance and all the other home ownership costs.

It’s bad enough assuming they just have the average-sized retiree mortgage. If they’re closer to the average Canadian mortgage of $170,000 and their income is in the lower third of the population, then well over half of their income would be consumed by home ownership costs. That is simply unmanageable and unfortunately there is no data on how many people are in this boat.

Apart from the cost, it’s often tougher to get approved for a decent mortgage in retirement. If your earning power has waned and you’re carrying even an average debt load, your ability to tap home equity for cash could be limited. Qualification challenges could even reduce your options to switch lenders or port your mortgage to a different house.

Even the “mortgage of last resort,” a reverse mortgage, could be off the table if you’re not old enough and/or you have an existing mortgage that’s more than 25-40 per cent of your home value.

So that brings us to the next question: what solutions do seniors have?

One is to work longer. Our neighbourhood butcher is still employed at 89 and that may not be so unusual going forward. Many Canadians expect to work past 65. They’re working 3.5 years longer than a decade ago and only 30 per cent anticipate being fully retired at age 66.

“If you have to work a few years past your retirement target date, do it and get rid of debt,” says Mr. Pape.

Another option for mortgage-holders is to get a fixed rate with a five-year term or longer. That protects those on fixed incomes from payment hikes. If you’re facing an underfunded retirement and you have a mortgage, “I would lock in a low rate while you still can,” he recommends.

You could also extend your amortization to 30 years. That maximizes cash flow in retirement and lets you make extra payments when you’re able. Couple this strategy with a home equity line of credit (HELOC) and you’ll get an emergency source of cash for unforeseen events like medical expenses or income loss. A “readvanceable” HELOC also lets you re-borrow any extra pre-payments if absolutely necessary, which lessens the cash flow risk of making them.

Despite these tips, the goal isn’t to manage a mortgage in retirement. It’s to avoid a retirement mortgage altogether. And to do that, you’ll need to start young.

The chilling truth is that there are just over 9.3 million Canadians age 55 and over and 43 per cent of them say they haven’t saved enough for retirement. But by 55, time is running out. A Statistics Canada study in 2009 found that people in their 70s spend only five per cent less than they did in their 40s. It takes years of saving to replace that kind of income and dispose of a mortgage.

By now, you’ve probably sensed that being pro-active is key. But many people haven’t been. As many as one in three say they plan to live off the equity in their homes. That’s a gamble in any real estate market. But if you’re retiring in the next decade and relying on uncertain home price appreciation, it’s especially risky. You need diversified savings and you need that mortgage out of the way.

This informative article appeared on CanadianMortgageTrends.com on September 30th, 2012 and was written by Rob McLister, CMT.

Big banks love mortgage consumers who don’t carefully comparison shop. They also enjoy capitalizing on their “home bank” advantage with existing customers. The article that follows examines recently-released research on these topics. It’s a revealing look at how big lenders benefit significantly from things like mortgage “search costs” and customer “switching costs.”

“Search costs” refer to the time, skill, money and effort required to find a better mortgage deal. “Switching costs” represent the expense of moving to a new lender.

The findings below come from a brilliant Bank of Canada research paper by Jason Allen, Robert Clark and Jean-François Houde. It’s chock full of insights into why mortgage consumers pay higher rates than they have to, and why being loyal to a lender can cost you.

The key findings of this research are summarized below. If you don’t have time to read them all, focus on the underlinedparts. CMT comments appear in italicized text and after the “Observations” labels. All quotes are taken directly from the study.

Consumers aren’t created equal:
Research shows that there are major differences in people’s:

• “Degree of loyalty to their main financial institution.”
• Ability to “understand the subtleties of financial contracts”
• Ability and willingness to “negotiate and search for multiple quotes”

Canadians generally don’t consider all available mortgage alternatives.

Hunting for a better mortgage:

• Many borrowers simply do not work as hard to “search” for a better mortgage. That’s largely because of the effort they “must put forth when gathering multiple quotes.”
• Inadequate mortgage research induces “profits for lenders” and “permit(s) them to price discriminate between consumers.” (It also raises your chances of getting stuck with bad mortgage terms.)
• “The average markup is estimated to be 4.1% for non-searchers and 1.9% for searchers, but the distribution is much more skewed for searchers with close to 25% of [comparison shoppers] facing zero markup (above the marginal cost).”
• In the past, “approximately 25% of borrowers [paid] the posted rate.” (This was based on data from more than a decade ago. The numbers are not as high now, especially for well-qualified borrowers. That said, there is no data to confirm how many people actually pay the posted rate today.)
• “…Consumers dealing with [large] institutions pay more on average for their mortgage.”
• Not surprisingly, the decision to switch lenders is “correlated with” the borrower’s willingness and ability to search for a better deal.
• “The fraction of ‘switchers’ is significantly larger” for:
• New homebuyers (i.e., former renters or [those] living with their parents), and for
• Broker customers (Lenders love to get their hands on first-time buyers, and it’s a big reason many are happy to pay brokers to deliver those customers.)
• “Consumers financing larger loans…are more likely to search (and pay lower rates).” In turn, they have a higher “switching probability.”
• “Richer households have a higher value of time, and therefore higher search costs on average.” (…and many of them needlessly overpay.) In short, they have less tendency to switch lenders.
• “…About 30% of consumers only consider dominant lenders.” (Usually a big mistake.) “For these consumers, the average number of lenders drops to three, which can significantly increase the profit margin of banks.”

“Home Bank” advantage:

• Everything else equal, a customer’s home bank usually gets their mortgage business. This is akin to a home field advantage in sports. (“Home bank” can also refer to a client’s “home lender.”)
• Even when all is not equal, the home bank often wins. That’s partly because consumers are “motivated by more than just price.”
• The study’s authors estimate that consumers are willing to pay “between $759 and $1,617 upfront ($13.80-$29.40 per month) to avoid having to switch banks.” (Many will pay more because they can’t quantify the value of lender differences. Case in point are mortgage penalties, which most people can’t measure until it’s too late—when they have no choice but to break their mortgage and pay whatever they’re quoted.)
• Put another way, “lenders directly competing with [a client’s] home-bank will on average have to discount the [mortgage] by a margin equal to the switching cost in order to attract” a new customer.
• The study finds that “loyal consumers pay on average nearly 9 basis points above the rate paid by switchers.” (It’s no coincidence that many borrowers choose to stay with their existing lender when a competitor’s rate is better by less than 10 basis points.)
• Not surprisingly, “the market for ‘non-loyal’ consumers is very competitive”

Factors that support customer loyalty to their home bank include:

• Proximity to a local branch
• Better access to lending terms
• Association with a strong recognizable brand
• Consolidation of accounts (for convenience)
• Lower chequing account fees, higher savings rates and other perks (Bank and credit union reps commonly use these perks to counter customer objections to higher mortgage rates. To some extent, free banking, banking comparison sites and modern-day electronic funds transfers are reducing the allure of these home lender “freebies.”)
• The cost and effort of switching bank accounts to a new lender (It isn’t necessary to have your mortgage and bank accounts at the same lender, but some people believe it’s important.)

Observation: The data used in this study is 11-13 years old. There is no way to know how much the home lender advantage has changed in that time. Various factors have altered this advantage over the last decade, including:

• Rate comparison sites — which make it easier to know when your lender isn’t being competitive
• More broker competition — Brokers reduce consumers’ search costs by assisting them with comparison shopping and offering comprehensive advice not biased to one lender. (Although, it should be noted that in most cases 90% of a broker’s volume is routed to three lenders, so there can be bias there as well.) “Unlike in the United States, brokers in Canada have fiduciary duties…The average discount that a mortgage broker can obtain for a borrower is about 20 basis points, or approximately $16 per month on a $140,000 loan.” (It’s likely lower now as this data is old.)
• Electronic banking — Many consumers want a mortgage that’s integrated with their banking. That plays right into the hands of deposit-taking lenders. Today, however, one can link different institutions’ mortgage accounts and bank accounts and electronically move funds between them with ease.

• “In 2004, 80% of new borrowers…contacted their main financial institution when shopping for their mortgage.”
• The research shows that, depending on the year, “nearly 60% of new home-buyers remained loyal to their main institution.” (CMHC’s Mortgage Consumer Survey finds that 88% of renewers remain loyal to their existing lender.)
• “…Only 35% of consumers dealing with brokers remain loyal to their home institution”
• 73% of households choose a lender with which they already have a prior financial relationship. The study authors estimate that “72% of consumers have a positive home (bank) bias.”
• “67% of Canadian households have their mortgage at the same financial institution as their main checking account.” (Having your bank account gives a bank an enormous advantage. Some have even been known to scan customer chequing accounts to see if they’re making a mortgage payment to another lender. The bank then contacts them ”out of the blue” to solicit their mortgage business.)
• Banks are more likely to transact with customers who are not motivated to search as hard. (These customers are low-hanging fruit for the banks.)

Home bank tactics:

• Bank_Status“Lenders…are open to haggling with consumers based on their outside options.” (We all know that, right?)
• “This practice allows the home bank to price discriminate by offering up to two quotes to the same consumer: (i) an initial quote, and (ii) a competitive quote if the first one is rejected.” (Savvy well-qualified consumers routinely reject their lender’s first quote.)
• Lenders know that “low risk and wealthy consumers represent lower lending costs.” For that reason, lenders offer “lower rates on average” to these borrowers.
• “The loan sizes and credit scores of consumers are particularly strong predictors of the rates they pay.”
• Lenders know financially constrained consumers have fewer options. These people “pay on average a premium equal to 14 basis points.”

Stats of note:

• At the time of this study, the “Big 8” (Bank of Montreal, Bank of Nova Scotia, National Bank, Canadian Imperial Bank of Commerce, Royal Bank, TD Canada Trust, Desjardins and ATB Financial collectively “controlled 90% of assets in the banking industry.”
• “Interest and fees generated from mortgages represent approximately 21% of total revenue for the largest banks.”
• “80% of new homebuyers require mortgage insurance.”
• This is the distribution of mortgages between a client’s main and secondary financial institutions:

Account                 Main FI    2nd FI   All other FIs
Mortgage (all)            67.4%     10.9%      21.7%
Mortgage(no broker)  70.3%     10.8%      18.9%
Mortgage (broker)      37.3%     30.6%      32.1%
Source: Canadian Finance Monitor survey conducted by Ipsos-Reid, between 1999 and 2007.

• “On average, borrowers pre-pay an additional 1% of their mortgage every year.”
• “Richer households are more likely to pre-pay their mortgage, which reduces the expected revenue for lenders.”
• “The (mortgage) transaction rate is on average 1.2 percentage points above the 5-year bond rate” but varies widely.”
• “The standard-deviation of retail (mortgage) margins is equal to 66 basis points.”
• At the time of the study, “80% of consumers transacted with a bank that has a branch within 2 kilometres of their new house” (In the electronic banking age, lender location has taken on less importance. Tens of thousands of customers now choose lenders located nowhere near their home—often in a totally different province.)
• Here’s an interesting finding from the U.S.: “Hall and Woodward (2010) calculate that a U.S. homebuyer could save an average of $900 on origination fees by requesting quotes from two brokers rather than one.”

Miscellaneous Findings:

• It is “unlikely that the posted rate is used to attract new customers,” say the authors.
• But why are posted rates still in existence? Well, the report states: “Banks have an incentive to post an artificially high interest rate that is not binding. Indeed, the pre-payment penalty is…evaluated at the posted rate valid at the signature date, rather than the (actual) transaction interest rate. Banks therefore have an incentive to raise the posted rate, in order to reduce their pre-payment risk.” (Many discount lenders—particularly broker-only lenders—don’t play these penalty games. They base your penalty on the actual rate you pay, which is much more fair than the big banks’ method of using posted rates.)
• “…Lenders can incur transaction costs in the event of default, therefore lowering the expected revenue from risky borrowers.” When a borrower defaults, lenders also face “lost revenue from complimentary products like other loans and saving accounts.” Hence, contrary to charges by many housing critics, mortgage insurance does not eliminate a lender’s risk. (For more on this see: Skin in the Game)

Implications of this data
Those of us who see borrowers overpaying on a regular basis know how important it is to compare mortgage options. But it’s interesting to hear the repercussions of not doing so, as articulated by a reputable academic source.

These findings should stick in regulators’ minds, especially as they contemplate policies that:

• discourage price discrimination
• support greater access to funding (via securitization) to promote lender competition.

Allen, Clark and Houde note that “policies designed to increase information about the market, (mortgage) contracts, or the availability of different lenders would be beneficial to consumers.” A good example of this is the Department of Finance’s penalty disclosure initiative—for which it deserves big applause.

Similarly, the authors conclude: “policies that encourage consumers to consider lenders other than their main financial institutions would reduce overall market power.”

About the Data: It’s important to note that this study’s data was comprised only of high-ratio insured mortgages arranged in branches between 1999 and 2001; It did not include brokered mortgages, very big or very small mortgages, applicants with extremely high or extremely low incomes, or conventional (uninsured) mortgages.

If you’re interested in more research about mortgage pricing, see: Getting the Best Mortgage Rate.

This article appeared on CBC.ca on July 7th, 2012.

The clock is ticking on Canada’s mortgage rules.

Come Monday, insured 30-year amortizations will be a thing of the past, and the shift means many buyers are scrambling to find a home and seal a deal this weekend, before time runs out.

As part of an attempt to cool the housing market and reduce household debt, the maximum amortization on government-backed mortgages will be 25 years.

“It will mean some people will not be able to buy into the market, some people will buy less into the market,” Finance Minister Jim Flaherty said in announcing the new rules last month.

Bruce and Denise Perrett, of Port Coquitlam, B.C., got married last year and wanted to buy a house, but they weren’t in a rush.

That all changed when the couple heard Ottawa was tightening mortgage rules.

For the Perretts, locking into a 30-year term as opposed to 25 years meant an extra $300 a month that could go to strata fees or property taxes.

They sprang into action and called their mortgage broker.

“She was right on it, she got us the approval and the next day we were rolling,” said Denise Perrett. “Then we found out we had to have an accepted offer by [July 9] and then we panicked and called our realtor.”

The new rules limit buyers’ purchasing power, said mortgage advisor Milka Lukacevic.
Deadline stress

For every $100,000 it’s about a $60 difference, and in an expensive market like the Lower Mainland, every penny counts.

But Lukacevic says the rush to take advantage before the rules change can carry a lot of stress.

“You can’t necessarily — because the rules changed in a matter of weeks — go out and find something just to try and get it on a 30- year.”

The Perretts spent 48 hours looking at homes and put an offer that was accepted last week on a property in Maple Ridge that has everything they want.

The best part is that they qualify for a 30-year mortgage.

“We probably wouldn’t have been able to afford to mortgage a house, or at least not the house we wanted, if we hadn’t jumped on it,” Bruce Perrett said.