The Bank of Canada sounded the alarm on growing household debt on Wednesday, taking aim in particular at the growing tendency of Canadians to take out lines of credit using home equity.

While the Bank has repeatedly warned on household debt levels in the past, on Wednesday it provided more detail about the type of debt Canadians are taking on, including its concerns about the rapid growth of so-called HELOC’s (home equity lines of credit).

The issue, as with any debt, is if these innovations or this access to debt is taken too far

“Like any financial innovation, home equity lines of credit have both positives and negatives associated with them,” Bank of Governor Mark Carney said during a press conference in Ottawa. “The issue, as with any debt, is if these innovations or this access to debt is taken too far.”

He pointed to the concerns raised by the country’s banking regulator, the Office of the Superintendent of Financial Institutions, which said earlier this year that some lenders were too lenient in providing home equity loans.

Mr. Carney’s comments build upon the release of the Bank of Canada’s Monetary Policy Report on Wednesday, a quarterly economic overview compiled by the central bank. The report highlights the explosive growth of HELOC’s and mortgage refinancings in the past decade, which have surged to $64-billion as of 2010 from $8-billion in 2001.

Canadians appear to be using such loans for two primary reasons, the Bank said. They are either paying down other higher interest loans, such as credit card debt, or using the money for everyday spending.

http://business.financialpost.com/2012/04/18/bank-of-canada-takes-aim-at-home-equity-lines-of-credit/

When our mortgage came up for renewal about a year ago, my husband and I did what many couples do and debated whether to go variable or fixed. What we never seriously considered was locking in to a fixed rate for a decade – that option wasn’t even on the table.

What a difference a year makes.

He says inquiries about the 10-year fixed mortgage rate picked up in January, when it first dipped below 4 per cent.

Now, he is seeing a “record” amount of interest in this product. “Nearly 60 per cent of our clients are currently choosing it, compared with around 5 per cent in previous years,” Mr. Gaetano says.

Although interest rates are expected to remain at their current low for the next several months, the Bank of Canada has indicated that a hike is on the horizon. And with Canadian households saddled with record debt, Bank of Canada Governor Mark Carney has repeatedly expressed concern about how people will be able to make their payments once borrowing costs rise.

The 10-year mortgage is “of considerable interest to people who are carrying a high debt load,” Mr. Gaetano says. The certainty of knowing that that their mortgage rate is secure for the next 10 years is most appealing to them, he added. In his 22 years in the mortgage business, he has never seen the 10-year mortgage rate below 4.5 per cent. “This is a tremendous opportunity.”

Robert McLister, the editor of the Canadian Mortgage Trends blog, says the spread between five and 10-year mortgage rates is as tight as he can recall. “The premium you are paying to know what your rate is going to be for 10 years is exceptionally reasonable on a historical basis.”

As of late last week, people with good credit could secure a 10-year fixed mortgage for roughly 3.85 per cent to 3.89 per cent. But there are indications that at least some lenders are feeling the squeeze of the ulta-low rates and could soon pull back.

Mr. Gaetano has in the past been a vocal supporter of the variable-rate mortgage. Not any more. “The reality is that that train has left the station. It is a dinosaur. Unless we see discounted variables like what we used to see at prime minus 80 [8/10ths of a per cent], there is no good reason to consider the variable.”

He believes home owners considering a four- or five-year fixed mortgage should be careful about setting themselves up for renewing at higher rates in 2016 and 2017, when he expects mortgage rates will be 60 to 70 per cent higher. “I think people are fully aware that their income is not going to be rising by that much,” he says.

Mr. Gaetano is concerned that people are not sufficiently prepared for what a rise in interest rates will mean to their mortgage payments. “With rates this low, any increment will be a dramatic increase from what they are paying today and it will be a shock.”

York University finance professor Moshe Milevsky says the longer the amortization of your mortgage and the time period over which you plan to make mortgage payments, the more attractive the 10-year rate looks when compared to the 5-year fixed.

His advice? “If you want to go with the 10-year, try your best to scrimp and save to shorten the amortization period.”

OTTAWA – Bank of Canada governor Mark Carney often talks about the danger of too much household debt — but he’s unlikely to do anything about it when he has a chance this week.

Economists are unanimous that Carney will hold back from raising borrowing costs on Tuesday when he and his policy council announce the new target interest rate.

It’s been at one per cent since September 2010, and had been even lower since the recession — leading to some of the lowest borrowing costs in Canadian history.

With the U.S. rate likely on hold until 2014, economists say it may be many more months before the Bank of Canada moves off one per cent, fearing that further widening the gap in the cost of money between the two countries will send the loonie into the stratosphere.

Last week, all 12 members of the C.D. Howe Institute monetary policy panel, comprising private sector economists and those in academia, were in agreement there should be no change to interest rates.

“They (central bank) are very concerned about the household debt situation and the strength of the housing market, and the overall stability of domestic spending, and it just isn’t consistent with an overnight rate below inflation,” said Douglas Porter of BMO Capital Markets, a member of the C.D. Howe panel.

“But unfortunately they face this eternal tension of a healthy domestic economy and a shaky external environment.”

As long as the U.S. continues to struggle, despite the occasional encouraging signal, and the European debt problems remain unresolved, the Bank of Canada will be loathe to add negative drag to the domestic economy by tightening lending conditions, he explained.

Where Carney may make news this week is an upgrade to economic growth expectation for this year.

In a recent interview, the governor talked about “firmer” conditions and better than expected momentum in the U.S. recovery. Since, Statistics Canada reported employment grew by a massive 82,000 jobs in March.

In the last monetary policy review in January, the central bank estimated the economy would expand by a modest 2.0 per cent this year and 2.8 per cent next.

Analysts expect the bank to raise 2012 growth a notch to the consensus economic forecast of 2.1 per cent this year, or perhaps slightly higher.

Just how much higher may influence when Carney feels comfortable about doing what he appears anxious to do, and that is bring interest rates back to normalized levels.

Although still a minority view, three of the 12 members of the C.D. Howe panel think the governor should nudge the policy rate up to 1.25 per cent as early as June 5, and five believe it should come in October.

“Some members urging a higher overnight rate over the coming year took a more optimistic view of global prospects,” the think-tank said.

“For the most part, however, the tendency toward a higher rate target stemmed from concern that Canada’s growth is too tilted toward housing and fuelled by rising household indebtedness.”

At 151 per cent of disposable annual income, Carney said recently Canadians have never been so indebted.

The chief concern, he said, was a shock to house prices or higher rates that would reduce household assets and increase financing charges, leaving little in consumers’ pockets for purchases that stimulate the economy.

While he said he was prepared to intervene in an emergency, Carney noted more direct policy actions, such as a further tightening of mortgage rules, would be preferable and effective.

http://www.canadianbusiness.com/article/79805–central-bank-unlikely-to-raise-interest-rates-for-fear-of-hurting-the-economy

Canada’s finance minister said on Wednesday he would rather not tighten mortgage rules again to curb high household debt and that banks themselves are taking on that job by becoming more strict with their lending criteria.

Jim Flaherty said he has seen signs of moderation in the Toronto condominium market and expects to see a similar trend in Vancouver, one of the country’s hottest real estate markets.

“Part of that is based on what I’m being told by people who build condominiums, and also what I’m being told by some of our banks about their standards becoming more stringent with respect to their loans for condominium development,” Flaherty told reporters in Vancouver after making a speech there.

Flaherty said it was up to markets to “fix” the housing and debt problem, not the government.

“I’ve tightened up the mortgage insurance market three times … I really don’t want to do it again,” he said.

“And I’m glad that some of the banks – at least one of the bank executives yesterday indicated that he ageed that actually the banks should exercise prudence and not rely on government to do it for them,” he said.

Bank of Nova Scotia Chief Executive Rick Waugh said on Tuesday that the simmering housing market gives reason for caution, but that it’s up to the country’s banks, rather than the government, to manage the risks of their massive mortgage portfolios.

Several other bank executives – Toronto-Dominion CEO Ed Clark in particular – have said they would welcome further government moves on mortgages.

The government and central bank have been warning Canadians of the dangers of taking on too much debt, particularly through mortgages, at a time of historically low interest rates and high housing prices. The ratio of debt to personal disposable income hit a record high last year and has moderated somewhat since then.

Despite some resemblance to the U.S. housing market prior to the crash, most economists expect a soft landing in Canada.

Flaherty has tightened rules three times since 2008 in the mortgage insurance market but left them untouched in the federal budget last week, to the surprise of many.

The budget did propose enhanced supervision of the federal housing agency that issues mortgage insurance. Flaherty said the banking regulator, the Office of the Superintendent for Financial Institutions, was studying the matter.

© Thomson Reuters 2012

For three years, the word on the street has been that interest rates have nowhere to go but up. But few Canadian commentators – other than David Rosenberg – got the call on rates right. Although the prime rate has risen since dropping to an all-time low of 2.25% in April 2009, the increase to the current 3% rate that has remained stable since September 2010 has been modest to say the least. Long-term rates, like fixed mortgage rates, have gone up and come back down during that time, such that one can currently lock in fixed rates under 3%.

York University’s Moshe Milevsky did a study in 2001, which he revised in 2007, and determined that borrowers are better off going with a variable rate mortgage instead of a fixed rate mortgage approximately 9 times out of 10. That said, we have to be close to if not already in that 10% sweet spot where fixed beats variable.

Despite the opportunity to lock in low rates today, it could actually be beneficial for the average Canadian for rates to rise. Conditions need to warrant rate increases and the Bank of Canada (which directly governs the prime rate) and the bond market (which indirectly governs fixed mortgage rates) won’t raise rates until the time is right. How soon that time comes depends partially on domestic influences, but also on our neighbours to the south and the current eurozone debt debacle.

Greece is a perfect example of why rates should rise. Greek participation in the European Union gave them access to cheap credit and helped facilitate some of the excess spending that has them where they are today. Despite bond markets demanding higher interest rates on Greek and some other European government bonds, market intervention by the EU has helped keep rates artificially low.

The U.S. Federal Reserve has been doing the same thing, buying up U.S. government treasury bills to keep U.S. rates artificially low as well.

It’s hard to justify how artificially low interest rates for an extended period are good for anything other than delaying the inevitable for some market participants.

Higher rates would have a negative impact on those of us with outstanding debt, as higher interest charges would follow. But Canadian debt levels have moved ever higher in recent years, likely a response to the low rates that have been in place in part to stimulate spending. Higher mortgage rates could protect us from ourselves by making higher debt levels more punitive and less tempting.

Furthermore, fixed income investors could benefit. The emphasis on “could” is key. Rising rates typically hurt those holding bonds because today’s bonds are that much more appealing than yesterday’s as rates go up. How much the hurt hurts is a matter of fact. But those renewing GICs or sitting on cash these days are desperately awaiting higher interest rates to help their savings grow. So higher rates could at least lead to higher returns for fixed income investors in some cases.

Higher rates could benefit stock investors. Once again, the emphasis on “could” is key. Higher rates usually mean the economy is improving and inflation is rising. This could be a good sign that corporate profits and corresponding stock prices are moving higher. That said, one has to wonder if low bond and GIC interest rates and cheap credit have pushed more money into the stock market than should otherwise be there. Rising rates could bring income investors back to the more traditional income investments like bonds and GICs from the blue chip stocks they’ve potentially flocked to in order to obtain yield.

Despite the purported uncertainty above on stocks and bonds, higher rates should at least contribute somewhat to restoring equilibrium to credit, debt and equity markets. Something seems wrong with near zero or negative real interest rates. That is, something seems wrong with a GIC investor earning 2%, paying 1% of that away in tax and 2% inflation resulting in an effective return of -1%. On that basis, something seems right about higher interest rates, whether we like it or not. What happens to mortgage debt, stocks and bonds remains to be seen.

Jason Heath is a fee-only Certified Financial Planner (CFP) and income tax professional for Objective Financial Partners Inc. in Toronto.

Despite soaring mortgage lending, Canadian banks are strong enough to absorb any hit that might result from a potential real estate correction, said Ed Clark, chief executive of Toronto-Dominion Bank.

Unlike U.S. banks, lenders on this side of the border did not get involved in the kind of risky practices that helped drive the U.S. housing boom of the previous decade and that ultimately caused so much carnage when the crisis hit in 2008, Mr. Clark told shareholders at TD’s annual meeting.

Canadian banks didn’t require government bailouts and were able to go out into the markets and raise significant capital to fortify their balance sheets over the last few years.

If the housing market corrects, the big banks are strong enough “that they could absorb that hit,” he said.

In answer to a shareholder question, Mr. Clark acknowledged that there are “slightly different views” about where the housing market is headed, but he noted that “we all think that Canada is not at risk of a U.S.-style meltdown.”

Even if real estate does correct, the drop won’t be as severe as the U.S. experience and banks will be prepared to absorb any potential losses owing to their strong capital positions.

Bank of Canada Governor Mark Carney has warned that elevated consumer debt levels represent the biggest domestic risk to the financial system.

Mr. Clark said Canadian policy makers are faced with a “classic macro-economic dilemma” as they try to deal with quickly rising consumer debt levels. On the one hand there is a need to keep interest rates low to maintain the economic recovery but it’s those low rates that are causing consumers to go out and take on more debt.

Ottawa has been responding by tightening the rules around mortgage lending, most recently with the introduction of proposed new requirements around underwriting and disclosure from the Office of the Superintendent of Financial Institutions.

Mr. Clark said OSFI’s draft rules would need “some tweaks” to make them “practical and implementable,” but in general “we are doing the right thing” to make sure the situation doesn’t get out of control.”

Economists are pretty much in agreement that the Bank of Canada, while still maintaining its interest rates at a stimulus-level 1.00%, also adopted a more hawkish tone in its latest comments.

Mark Carney, governor of the central bank, highlighted an improving global economic outlook while also noting that household debt burdens have become the biggest domestic risk. Enough grist for the mill, certainly, for economists to begin speculating about Mr. Carney accelerating his plan to eventually raise rates again. At some point in the future. Possibly. (You know how it is).

While quite subtle, the associated rate statement signalled a possible lack of patience with the status quo,” Mark Chandler, head of Canadian fixed-income and currency research with RBC Capital Markets, said in a note Friday.

However, the real question is what Mr. Carney plans to do about the growing debt problem.

“Over the past couple years, the presumption had been that household debt accumulation was largely a sector-specific problem tied to housing prices and associated mortgage credit growth,” Mr. Chandler said.

Problem was, direct measures introduced in the past two years, including lowering the maximum amortization period to 30 years and requiring borrowers to qualify for at least a five-yeare fixed-rate term even if they choose a lower rate or term, have been largely ineffective at pushing the debt needle back.

“One can argue that additional capital requirements should be part of the solution (as per Basel III) but financial institutions are already scrambling to build core capital requirements required under the new rules,” he said. “If the macro-prudential tool is unavailable, the burden could (or should) fall to monetary policy.”

On the other hand Sheryl King, Canada economist with BofA Merrill Lynch, argues against a rate hike due to its likely negligible impact on bond yields, which are used by the banks to determine mortgage rates. Bond yields have been weak ever since investors, fearful of roller-coaster equities in the wake of the financial crisis, have been flocking to fixed income for guaranteed yield.

“The more effective and direct policy tool for the mortgage market, in our view, is tighter regulation,” she said.

For example, if Canada further reduced its maximum amortization period to 25 years from 30, it would be the equivalent of a 95 basis-point rise in the five-year fixed rate mortgage.

The U.S. Federal Reserve, which faced a similar conundrum under the stewardship of Alan Greenspan between 2004 and 2006, was only able to achieve similar results through a 400 bps increase in the rate, she said.

Fixed-rate mortgages are at historic lows but if you are locked in to a contract with your bank, those benefits may be yet elusive.

First you have to do the math to see if breaking your contract is worth the penalties you may face.

“There is no grey area,” says Cindy David, a certified financial planner at Dupuis Langen Financial Management Ltd. in Vancouver. “It’s either worth it or it’s not.”

The big five banks are offering four and five year mortgages at just 2.99%.

“We’re even seeing 10-year fixed rate mortgages at 3.99%,” says Ms. David. “Think about that: Interest and principal at 3.99% for 10 years. From a financial planning perspective if any client approached me and said ‘Should I look into breaking my mortgage?’ My answer would be yes.”

Step one comes down to meeting with your financial institution and doing the math to determine whether or not the cost of breaking your mortgage is worth the anticipated savings from the lower rates. The fact is the penalty for breaking a mortgage can be thousands of dollars and in many cases, the cost and the future savings cancel each other out, in which case you may be wise to wait until your mortgage is up for renewal

OTTAWA • The federal government and some of the country’s leading economists remain worried about Canada’s housing market and rising household debt, and are cautioning Canadians against borrowing too much.

However, they are more optimistic about the overall state of the Canadian economy than they were just last fall, and now project stronger-than-expected economic growth in 2012.

Finance Minister Jim Flaherty met Monday with 13 private-sector economists for his traditional pre-budget consultation to get their assessment of the economy as Ottawa prepares to deliver the federal budget on March 29.

Mr. Flaherty and a handful of the economists said they continue to be concerned about household debt levels in Canada and a somewhat overheated housing market — especially on condominiums. The Minister was also cautioned about cutting more than $4-billion in annual spending that the government first identified last year.

Some of the big banks are suggesting the federal government also consider implementing “measured actions,” such as reducing the maximum amortization period for mortgages back to 25 years and increasing the minimum down payment, possibly to 10%.

“There has been some moderation in the housing market. I remain concerned about the condo market, quite frankly,” Mr. Flaherty told reporters after his one-hour meeting in Ottawa.

“I again encourage Canadians to be careful in the amount of debt they take on in terms of residential mortgages because (interest) rates will go up some day.”

The Minister, however, noted there’s a “divergence” in opinion among the economists, as some expressed more concern than others about the state of the housing market.

Avery Shenfeld, chief economist at CIBC World Markets, echoed some of Mr. Flaherty’s worries and said that while there are signs the housing market is cooling off, there’s still cause for concern.

“There’s a general feeling that, more than just the condo market, the Canadian housing market is starting to get a little bit overdone in terms of price momentum,” Mr. Shenfeld said.

He noted the Canadian economy in 2012 is likely to expand a few decimal points more than the 2.1% growth in real gross domestic product that was predicted in November’s fall economic update.

“It’s fair to say that some of the risks we were worried about last year don’t seem quite as shocking as we go into the current year,” Mr. Shenfeld said.

The federal government bases its budget and economic projections on the average forecasts of private-sector economists it regularly consults. The economists said they’re waiting a few more days for the most recent GDP figures to trickle in before releasing an updated average.

Derek Burleton, deputy chief economist at Toronto-Dominion Bank, said he also is worried about the state of the Canadian housing market and would like the government to consider reducing the maximum amortization period to the traditional 25 years from the current 30 years.

Increasing the minimum down payment to 10% from the current 5% is another option, he said, but one that must be carefully considered.

“I do believe that there is some scope to take some further measured actions. I am concerned about the condo market quite a bit,” Mr. Burleton said.

Reducing the maximum amortization to the traditional 25 years wouldn’t generate any drastically negative impacts, he said. The government had increased the maximum period to 40 years, but slowly ratcheted it back over the past few years to the current 30 years.

Mr. Burleton also noted borrowing trends have picked up in recent months after a cooling-down period, and is worried the uptick will continue.

Douglas Porter, deputy chief economist at BMO Capital Markets, cautioned the government against searching for more than the $4-billion in annual cuts the Conservatives identified in last year’s budget.

The Harper government’s program review is searching for a minimum $4-billion — and up to $8-billion — in annual savings over the next few years, but Mr. Porter said the government should tread carefully.

“I would not advocate for the federal government to ramp up the pace” of cuts beyond what was already announced in last year’s budget, Mr. Porter said, adding federal finances are now in better shape.

“There is not a push from the financial markets for the federal government to do any more than what’s already scheduled.”

However, Mr. Porter is not as skeptical of the Canadian housing situation, saying the markets remain fairly well-balanced across the country.

“I don’t get the impression that the housing market has been particularly overdone,” he said.

Posted in: Economy  Tags: Canada economy, Jim Flaherty

Three annoying things that banks do to customers are about to become history.

Following up on commitments made in the past two budgets, the federal government has announced measures that will stop banks from mailing unsolicited credit card convenience cheques to customers, and that will reduce the holding period on newly deposited cheques. The banks will also have to stop being so secretive about the penalties clients must pay when they want to get out of a mortgage early.

These measures represent some good work by a government that has been under pressure lately as a result of the robo-call affair. Strangely, the measures were announced on a Sunday and thus didn’t get the initial attention they deserve.

The sharp decline we’ve seen in mortgage rates over the past few years has prompted many people to think about breaking their mortgages in order to lock in lower borrowing costs. A mortgage penalty must generally be paid in this situation, but it’s exceedingly difficult to find out how much it is and how it’s calculated.

The government said in its 2010 budget that it would standardize the calculation and disclosure of mortgage penalties. The measures just announced don’t address the fact that mortgage lenders use different methods to calculate penalties, some of which hit borrowers harder than others. But they do require banks to:

• Annually show customers how they can pay off their mortgages faster without incurring prepayment charges.

• Provide online mortgage penalty calculators.

• Offer a toll-free phone line that customers can call to talk to bank staff about mortgage prepayment penalties and find out the actual charge that would apply.

• Disclose the details of how actual mortgage prepayment penalties are calculated (example: whether three months’ interest is being used, or a calculation called the interest rate differential that looks at how much interest a bank is losing out on if you break your mortgage).

These rules will be introduced over the next six to 12 months or so, and they apply specifically to new mortgages. The Department of Finance says the measures will be applied to existing mortgages “where it is feasible to do so.” Business mortgages are not covered.

Improved disclosure of penalties will make life easier for borrowers who want to get out of a mortgage before the renewal date. “I can’t tell you how many borrowers call us to say, ‘How can I figure out my penalty?’” said Vancouver mortgage broker Robert McLister. “We generally have to tell them to call their lender, and then they have to endure a sales pitch from the lender – why are you leaving and things like that.”

The new mortgage regulations will require banks to show how they arrive at a mortgage prepayment penalty. However, they don’t standardize the calculation method. As it stands now, some lenders are more punitive than others with their penalties. For example, mortgage broker Jim Tourloukis said some lenders will calculate a penalty of three month’s interest based on the actual interest rate a client has, while others will use the higher posted rate that almost nobody pays.

“Without a doubt, the calculations should be standardized,” Mr. Tourloukis said. “It’s a dog’s breakfast right now.”

The government’s ban on the distribution of unsolicited credit card convenience cheques will come in proposed regulations to be published for consultation in the weeks ahead. Let’s hope there’s no slippage on this file because credit card convenience cheques exist to prey on people who can’t handle credit (here’s a column I wrote last fall on these cheques.)

Some key negatives: These cheques allow you to draw on your credit card balance for things that you can’t usually pay for with plastic, like rent or utility bills, and using them is like taking a cash advance on your card. That means you forgo the usual interest-free grace period credit cards offer.

The new rules for cheques take effect Aug. 1. They’ll limit banks to a four-day hold on newly deposited cheques of less than $1,500, which is down from five to seven days right now in many cases. Also, banks will have to provide immediate access to the first $100 deposited in a branch; for cheques deposited by bank machine, access to the first $100 would come the next business day.

That’s three annoying bank practices addressed by Ottawa. Suggestions for future government investigation: Aggressive marketing of bank mortgage life insurance, high dormant-account fees and branch staff who are called financial planners but only flog mutual funds.