The residential mortgage – easy street for borrowers


I have been trying to figure out if the borrowers are so tight on cash (as reported in many newspaper articles, how do they manage to survive the 5-year renewal? Silly me, it’s just that I don’t understand the rules.

Let’s Look at an Example Mortgage Situation

To get things rolling, let’s look at an example. I borrow to buy a principal residence and select the 5-year fixed promotional rate of 2.45% (example only). So I am happily paying an astoundingly low rate of interest. This goes on for five years and interest rates remain unchanged for the sake of argument. The posted 5-year rate is now 4.99% but the promotional rate is still 2.45%. Now you would have thought that the five-year promotional rate was just that, a promotional rate. It should go to, say, first-time homebuyers or new customers. Wrong. Because of the competition for mortgage assets, another bank will do the refinancing at 2.45%. So your bank matches it because they don’t want to lose the asset. Bingo! The five years have come and gone and you are none the worse off.

So borrowers have not felt the pain of the renewal coming up and to have the interest rate calculated at the posted 5-year fixed rate. So the issue of rising interest rates will only become one if and when there is a general increase in rates. When I had a mortgage and we came up for renewal, the only thing the lender/bank was concerned about was what rate I would select and the term. Even if rate increase, the borrower will still have the choice of selecting a product that eases the rate pain, not necessarily having a significant jump in rates.

So the “games’ continue with the borrowers not having to “face the music” until such time as there is a general increase in rates, where all the rates shift up including the promotional rates.

What’s the Big Deal With Mortgages?

Now you may wonder what the big deal is with mortgages. Why are the banks so interested in getting these deals done? It’s a bit complicated, but for those of you who are “newbies” it takes just a bit of explaining.

With the interest rates so low, banks need to invest in assets that yield a reasonable rate of return. Traditionally, they would invest their excess cash in government issued instruments. But right now, those investments have a negligible rate of return. At the same time, you have CMHC guaranteeing mortgages that do not meet the 20% deposit rule. At the same time, the amount of capital or equity that the banks have to reserve for government guaranteed or high deposit assets is low. So their return on the capital set aside for the mortgage is high. Makes perfect sense. You have a historically secure asset with a high return on capital invested. At the same time, the cost of funds borrowed to finance these assets is low. CIBC Cashable Escalating Rate GIC (3- or 5-year term) 0.8666%. 3-year effective yield. The offsetting asset still generates enough of a return to make the business viable for the bank, otherwise, they wouldn’t do it. It’s not complicated.

So on it goes, the return is sufficient to allow everyone to be happy!

So in the end, until there is a general upwards move in interest rates, this will go on. But a 1% or 2% rise in interest rates has the potential to be a game-changer.