Credit card roulette

will dunning

From Thursday’s Globe and Mail

Published Thursday, Dec. 29, 2011 2:00AM EST

Credit card lending is starting to look a lot like airline travel did a generation ago.

In those times, government regulations set minimum airfares, at levels that would have allowed the airlines to be very profitable. Since they weren’t allowed to compete on price, airlines competed in other ways, including free food and drinks, and service. To a large degree, they “competed away” their potential “excess profits.”

Now that airfares have been deregulated, prices are very competitive, but the perks have been reduced significantly. While consumers miss the freebies, and we often grumble about airline service, we have been made much better off by the advent of price competition.

In the credit card arena, lenders haven’t yet found a way to compete on price, so they follow a similar model of competing through other offerings. These include points, cash-back schemes, and insurance programs. The credit card issuers’ behaviour is analogous to the airlines of earlier times. And, like the airlines, these perks have the effect of “competing away” some of the “excess profits” that might be earned in a market that’s not competitive on pricing.

In fact, lenders have found another avenue for competing away the excess profits. This one, fortunately, was never adopted by the airlines: They’re taking on added risk.

The Canadian Bankers Association reports that, at the end of July, 1.05 per cent of Visa and MasterCard balances were delinquent by 90 days or more. This is more than 2.5 times the arrears rate for mortgages, which was 0.40 per cent at the same date. Indeed, if one were to track the arrears rate of both credit cards and mortgages, one would find that, since 2004, credit card arrears have been triple that of mortgage arrears.

Further illustration of the riskiness of credit card lending is provided by the CBA’s data showing that write-offs at the end of July amounted to 3.91 per cent of total outstanding balances (at an annualized rate).

Some lenders are calling for increased regulation of mortgage lending. Mortgage lending is already quite highly regulated and, in Canada, is a quite safe form of lending, as illustrated by the CBA arrears data. Indeed, the federal government has already made three sets of changes to its financial guarantee of mortgage insurance since 2008. The last series of changes resulted in a significant reduction in refinancings by Canadian households, according to mortgage default insurers, including CMHC and Genworth Financial Canada.

If lenders were writing off their mortgages at the same rates as credit card balances (currently 3.91 per cent a year), it would be nothing short of catastrophic for them and for the Canadian economy.

Strangely, though, credit card issuers aren’t calling for increased regulation of credit card lending – an activity that’s much less regulated and much less competitive than mortgage lending, and is more profitable.

Will Dunning is an economic consultant who specializes in analyzing housing markets.

By Sunny Freeman, The Canadian Press

TORONTO – Canada’s housing sector is edging closer to a sellers’ market as sales and prices jumped again in November, but the number of listings dropped off.

Home resales rose six per cent last month on a year-over-year basis and jumped 0.5 per cent on a seasonally adjusted basis compared to October levels, the Canadian Real Estate Association said Thursday.

November marked the third straight month that national activity on its Multiple Listing Service was up from the one before.

The national average price increased 4.6 per cent year-over-year to $360,396. And while prices continue to rise, CREA noted that November’s increase was the smallest jump since January. Meanwhile, the number of newly listed homes was down 3.4 per cent from October to November.

“The national housing market remains balanced, but is edging closer to seller’s market territory,” the association said in a release.

A sellers’ market occurs when demand outweighs supply and owners can fetch a higher price for their homes in bidding wars between buyers.

The latest signs pointing toward a market that favours sellers stand in stark contrast to predictions earlier this year that demand would drop off, giving buyers a break from rapidly rising prices.

But a continuation of ultra low interest rates — which have sat at one per cent since September 2010 — due to trouble signs outside Canada’s borders has kept demand strong and buyers competing.

New listings slipped lower in more than two-thirds of Canadian housing markets, with Toronto, the Hamilton-Burlington region, and Calgary falling the most. The national sales-to-new listings ratio a measure of market balance, rose to 55.5 per cent in November — its highest reading since the spring.

Sales activity rose in about 60 per cent of all local markets, CREA said. Record November sales in the Halifax-Dartmouth region offset a dip in sales in the white hot Toronto market.

“The Canadian housing market is proving resilient in the face of ongoing global economic and financial uncertainty, to the benefit of Canadian economic growth,” said Gary Morse, CREA’s President.

And while sales so far this year have been stronger than expected, up 2.1 per cent on a year-to-date basis, they have remained in line with the 10-year average.

However, sales in November were so robust, that they broke that pattern to climb seven per cent above the 10 year average to the fourth highest level on record for the month.

But CREA’s chief economist Gregory Klump noted that the upswing heading into year-end is similar to what happened last year.

“By contrast, national average price also picked up toward the end of last year, whereas this year it has held steady after having peaked in the spring,” he added.

For the first time this year, Klump acknowledged that the hot real estate market — driven in part by a persistent low interest rate environment that is expected to last well into next year — could lead to signs of trouble.

“With interest rates expected to remain low for longer, the housing sector will no doubt be closely watched for signs of excess,” said Klump.

“That said, current trends for resale housing and new home construction suggest that tightened mortgage regulations are working as intended and fostering economic stability in Canada.”

Heavy borrowing activity signals dark clouds on the horizon for some households as debt reaches record levels — as much as 153 per cent of disposable incomes, according to data released earlier this week.

The most over-leveraged Canadians could find themselves unable to cope when interest rates eventually rise, federal Finance Minister Jim Flaherty and Bank of Canada governor Mark Carney have warned.

A total of 432,048 homes have changed hands on CREA’s MLS system so far this year, that’s about 0.7 per cent above the 10-year average.

5 reasons why a fixed-rate mortgage could be your best bet

By Tom McFeat, CBC News

It’s a decision that millions of Canadian homeowners struggle with repeatedly during their time as homeowners: Do they choose the security of a fixed-rate mortgage, or opt for the flexibility (and usually lower cost) of a variable rate and hope that rates don’t spike higher? But right now, conditions in the mortgage market mean homeowners can actually get the best of both worlds, according to market-watchers.

(Source: CMHC)

For years, we’ve seen evidence that people who opted for variable-rate mortgages ended up saving money over the fixed-rate crowd —anywhere from 77 to 90 per cent of the time, depending on the period selected and the assumptions used.

Despite that, 60 per cent of the 5.8 million mortgages out there are fixed-rate mortgages, and the five-year term is especially popular. Another 31 per cent of mortgages are variable- or adjustable-rate. The rest are hybrids that have a bit of both types of mortgages built in.

In the past year, we’ve seen evidence that people have been starting to swing more towards variables (see table). But in the past few months, two things have happened in the Canadian mortgage market that may have the “variable-is-best” crowd changing their minds … or at least re-thinking what used to be an easy decision.

Variable has a catch

First of all, the traditional discount that lenders used to apply to variable rate mortgages is fast becoming a thing of the past.

“In the last couple of months, there’s been a big shift back to fixed rates,” says mortgage broker Robert McLister, who edits the popular mortgage news site CanadianMortgageTrends.com. “The average discount went from prime minus 0.80 per cent to prime minus a quarter,” he told CBC News.

Widespread discounts

• Average posted 5-year fixed-rate mortgage: 5.38%
• Average discounted 5-year fixed-rate mortgage: 3.92%
• Average discount: 1.46 percentage points

Source: CAAMP/Maritz survey, Fall 2011

That puts a typical five-year variable-rate mortgage around 2.75 per cent.

At the same time, McLister says fixed rates have dropped. Mortgage brokers can arrange a five-year fixed-rate mortgage for as little as 3.25 per cent – or about two full percentage points below the posted rates at the big banks. That rate represents a spread of just half a percentage point over the variable-rate mortgage. McLister says the spread between these two is normally 125 basis points or more (1.25 percentage points).

At this point, you may be thinking that people who have variable-rate mortgages still can’t lose, because they can always choose to lock in to a fixed-rate mortgage at any time. Very true. But McLister points out that people who do this typically don’t get the lowest rates.

That’s not too surprising. After all, you can’t change lenders when you switch from a variable to a fixed mortage without paying a penalty, and your lender knows this. “The rates that lenders give to people when locking in are always at least a quarter percentage point above what’s available elsewhere in the market,” he says.

McLister also points out that it’s never immediately clear where or when mortgage rates will bottom out. “Some people may think about getting a variable in hopes of riding down rates if they drop further,” he says. “The thing is, if you’re that good at predicting interest rates, you’d make a lot more money as a bond trader.”

What people are choosing

Source: CAAMP/Maritz survey, Fall 2011

Fixed-rate bargains

Of course, there are other reasons besides interest rates that can sway someone’s decision on mortgage type. If someone needs to break a five-year fixed rate mortgage early, for example, the penalty (based on what’s called the interest rate differential) can be many thousands of dollars. With a variable-rate mortgage, the penalty is never more than three months interest.

By the numbers

• Interest rates in Canada and around the world
• Map: Canadian housing prices

But some people will always opt for fixed-rate mortgages simply for the security of knowing that they won’t be affected by any future upswing in interest rates – at least until their mortgage comes up for renewal.

Here’s another reason to consider fixed-rate mortgages. Some lenders have chosen to stake out some market share by offering exceptional bargains at terms other than five years.

The four-year fixed-rate mortgage – not a mainstay among the big banks – has become a battleground among some other lenders that mortgage brokers use. Brokers can arrange a four-year fixed-rate mortgage for 2.99 per cent at a few non-bank lenders, and the range generally available right now goes from 2.89 per cent to 3.09 per cent.

One big bank lender – Scotiabank – offers a two-year fixed-rate mortgage for 2.49 per cent, which is even less than what lenders charge for a variable-rate mortgage.

As for the future, some mortgage experts see the variable-fixed spread continuing to narrow.

‘Variable mortgage rates will stay at current levels well into 2012’—RateSupermarket.ca

“Variable mortgage rates will stay at current levels well into 2012,” says a panel of five mortgage industry and academic experts surveyed by RateSupermarket.ca in December.

At the same time, the panel members predicted that fixed mortgage rates would stay low or drop further over the next 30 to 45 days, noting that there’s less demand for home loans over the holdays.

Still not sure what to go for? Fixed or variable? Short or long-term?

Either way, the good news is that rates are at historic lows. Rest assured that you can’t go far wrong these days, no matter which direction you go in.

“The cost of choosing the wrong term has probably never been lower,” says McLister.

Transitioning from Renter to Homeowner

 Transitioning from renter to homeowner is one of the biggest decisions you’ll make throughout your lifetime. That’s why it’s essential to surround yourself with a team of experts – including both a mortgage and real estate professional – to walk you through the steps to home ownership, answer all of your questions and concerns, help you decide what kind of home you can afford and get you pre-approved for a mortgage. The mortgage professionals at Dominion Lending Centres are available anytime day or evening to help get you started.

 With interest rates still hovering around “emergency” levels – low rates never before seen by your parents and even your grandparents – now is an ideal time for first-time homebuyers to embark upon homeownership.

 Down payment

The main reason many renters feel they can’t afford to purchase a home has to do with saving for a down payment. But there are many solutions available today that can help first-time buyers with their down payments.

 Many lenders will allow for a gifted or borrowed down payment. And of those lenders that will not provide this alternative, many offer cash-back options that can be used as a down payment.

 Better yet, there are programs available from some financial institutions where they will offer a “free down payment” or a “flex down”. Of course, you will end up paying about 1% more in your interest rate, but the program will help you get in the homeownership door and start accumulating equity earlier. You must, however, stay with the original lender for the full initial five-year term or else you’ll have to pay the down payment back.

 Last year, a $5,000 increase was made to the RRSP Home Buyers’ Plan, meaning first-time homebuyers can now withdraw up to $25,000 from their RRSPs for a down payment – tax- and interest-free.

 And if you’re part of a couple making a home purchase together, you can each withdraw up to $25,000 from your RRSPs.

 Educating and coaching

There’s an endless amount of information available to prospective homeowners – through the Internet, friends, family members and anyone willing to voice their opinion on a given subject. What you really need, therefore, is education and coaching as opposed to being bombarded with more information.

 Speaking to a mortgage professional at Dominion Lending Centres in order to obtain a pre-approval prior to setting out home shopping can help set your mind at ease, because many first-time buyers are overwhelmed by the financing and buying processes, and often don’t know what it truly costs to purchase a home. Real examples can go a long way in showing you what it costs to buy a home in your area versus what you’re currently paying in rent. For instance, if a renter is currently paying $800 per month, with that same payment (including taxes) they could afford to buy a $120,000 home. And assuming real estate values increase 2% per year over the next five years, the new homeowner would have accumulated $27,000 in equity in their home. If they continue renting, however, this $27,000 has generated equity in someone else’s home.