Category Archives: Home Buyers Plan

Financial News: How will Bank of Canada cuts to the interest rate affect the Canadian Housing Market?

SOURCE: FINANCIAL POST: Ari Altstedter, Bloomberg News | January 21, 2015

The bond market is suggesting an overheated Canadian housing market is about to get even hotter just in time for the spring thaw.

The Bank of Canada unexpectedly cut its main interest rate, saying the oil-price shock will drag down inflation and weigh on everything from exports to business and consumer spending.

The bank cut its rate on overnight loans between commercial banks by a quarter percentage point to 0.75%, a decision none of the 22 economists in a Bloomberg News survey predicted. The rate, which influences everything from car loans to mortgages, had been at 1% since September 2010. The last cut was in April 2009.

Five-year bond yields, which serve a benchmark for mortgage loans, are at a record low. Anticipation of increased lending has helped push the cost to hedge mortgage loans by banks to the highest level since August 2013, when frenzied activity in the housing market prompted authorities to clamp down.

With oil prices depressed to 5 1/2 year lows and both the International Monetary Fund and the World Bank cutting growth forecasts this month, traders have pushed out expectations for when central banks in the U.S. and Canada will raise benchmark interest rates. That’s caused the wholesale rates available to banks in the bond market to fall before the country’s traditional spring home-buying season.

“Real estate, it has nine lives,” said Benjamin Tal, deputy chief economist at Canadian Imperial Bank of Commerce, by phone from Toronto. “Every time it’s supposed to slow down because of interest rates, something bad happens elsewhere that keeps interest rates low. That’s exactly what we’re seeing now.”

The average five-year mortgage rate in Canada is a record-low 4.79%, according to central-bank data. Lower rates can be obtained from banks and other private lenders.

Rate Cut Impact

Economists say Canadian borrowers can expect mortgage rates to dip slightly in response to the Bank of Canada’s surprise move to cut its trend-setting interest rate.

CIBC chief economist Avery Shenfeld says that will likely mean a corresponding 0.25 drop in variable, or floating, mortgage rates.

Fixed-rate mortgages are also likely to see a slight decline, as they follow bond yields, which will move lower in response to the central bank’s rate cut.

The rate cut could boost sales and prices of homes in Central and Atlantic Canada, including in Toronto’s red-hot property market.

TD economist Craig Alexander says lower interest rates could spur consumers in non-oil dependent provinces such as Ontario to take on more debt, which in turn will boost the region’s real estate market.

However, Alexander says it’s unlikely that consumers in oil-rich Alberta, who are reeling from the impacts of the sharp decline in energy prices, will increase their debt loads or see sales or prices of homes heat up.

Policy Meeting

A month ago, traders were pricing in an 83% chance the Federal Reserve would raise the key U.S. rate by the end of 2015, according to Bloomberg calculations based on overnight index swaps. Tuesday, the chances were 66%. In Canada, traders now see a greater likelihood of a decrease than a raise.

The gloomy outlook has increased demand for bonds, pushing the yield on five-year debt from the Canadian government to a record-low 0.786%.

At the same time, the cost for the securities banks use to hedge mortgage liabilities, the five-year swap spread, has risen.

The premium banks must pay over five-year government securities for a five-year interest rate swap — the rate to exchange floating- for fixed-interest payments — climbed as high as 46 basis points this month.

Anticipating Hedging

“The banks aren’t hedging yet, but other investors are anticipating the hedging activity and they’re basically front- running the banks,” said Ruslan Bikbov, a fixed-income strategist in New York at Bank of America Corp. “Mortgage rates, basically they have to decline.”

With consumer debt including mortgages at a record level and real estate valuations still rising, Canada’s situation today echoes the summer of 2013, when the nation’s housing agency rationed guarantees on mortgage-backed securities to help keep the market from becoming a bubble. That March, then-Finance Minister Jim Flaherty, who had already tightened mortgage rules, rebuked Bank of Montreal for reducing its five-year mortgage rate below 3%.

At the time, the benchmark five-year rate was 1.3%.

“This spring, in both the investment season and in the mortgage season, we hope to again have a fresh offer that is appealing to customers,” William Downe, chief executive officer of Bank of Montreal, said at Jan. 14 conference in Toronto. “And so in that sense, it isn’t a question of competing on price. It’s a question of competing on value.”

Housing Surge

Housing prices have continued to gain across the country, particularly in the largest cities. In Vancouver, the average home price jumped 27% since December 2008, according to the Canadian Real Estate Association. Toronto home prices rallied 49% in the same period to $521,300 in December 2014.

This year, there’s no guarantee the banks will respond to the lower rates in the bond market by lowering mortgage rates, and even if they do, there’s no guarantee cheaper mortgages will further inflate housing values, according to CIBC’s Tal.

His own research shows an estimated 30% to 40% of Canadian households are taking advantage of low interest rates to pay back their mortgages to shorten their amortization, reducing the risk of an interest-rate shock.

Last month, the Bank of Canada said housing prices are overvalued by as much as 30%, posing an “elevated” risk to the domestic financial system.

“If we borrow more, that will add to the ultimate adjustment,” Tal said. “But that depends on what we do. We have seen in the past that Canadians use low interest rates to actually pay down debt faster, as opposed to add to their debt. If that’s what we do, it’s a good thing.”

Bloomberg News, with files from the Canadian Press

Want to buy a house within the next five years? Consider taking a Home Buyers Plan (HBP) withdrawal from your RRSP

We recently came across this article in the January 12, 2015 edition of the Star Phoenix by Terry McBride, a member of Advocis, and thought we’d share it with you. These sound tips will help you figure out how to contribute to your RRSP. In particular, a Home Buyers Plan can help you save for a down payment on your home:

Most Canadians feel they can’t afford to contribute to a Registered Retirement Savings Plan (RRSP) because they have too many other money

However, you probably could afford to make RRSP contributions by systematically depositing small amounts monthly. Think of how effortlessly wage earners make income tax, CPP and EI payments by payroll deduction.

Automatic deposits

What can you afford?

Even $50 per month is a good place to start. Enrol in your employer’s group RRSP. Take advantage of any matching deposits your employer is willing to add to your savings. If you have no group RRSP plan at your workplace, then arrange for a pre-authorized electronic funds transfer at your bank.

Typical RRSP investments available for such monthly-deposit plans include mutual funds, which let you fully invest even the smallest contributions. Stock market downturns will have less of an impact when you realize that you will automatically accumulate more mutual fund units whenever prices decline. You’ll also buy fewer units while prices rise.

Reduce tax withheld

When you contribute to your RRSP on a monthly basis, you can arrange with your employer to reduce the amount of tax withheld from your paycheques. Fill out Canada Revenue Agency’s Form T1213, Request to Reduce Tax Deductions at Source.

Let’s say your taxable income is over $43,953, for example, and you are in a 35 per cent tax bracket (using Saskatchewan rates). Rather than waiting for a $210 tax refund from claiming the $600 annual total RRSP contribution on your tax return, your reduced source deductions provide your tax savings immediately.

Take that reasoning one step further. Use the cash flow, freed up by reducing source deductions, to contribute that much more to your RRSP. If you could afford $50 per month before, then you can afford to increase monthly deposits to $77 per month once you have arranged to have $27 less tax withheld at source.

Borrow refund

For some people, borrowing to make a top-up contribution before the March 2 RRSP deadline can be useful when you have some cash to start with. You can get an RRSP loan interest rate that is close to the prime rate (currently 3 per cent).

You should use your income tax refund to pay down your RRSP loan. Indeed, the ideal amount to borrow for a short-term RRSP loan is the same as the dollar amount of the tax refund you expect.

For example, let’s suppose you have $3,000 cash (C) available to make your contribution. Your 2014 taxable income is between $43,953 and $87,907, which puts you in the 35 per cent marginal tax bracket (T). The tax you would save without borrowing is C times T, which is $1,050.

However, if you borrow $1,615 (B) and you contribute a total of $4,615, then your tax refund would be $1,615, which would be just the right amount needed to completely pay off your RRSP loan.

Convert your tax rate into a decimal fraction (0.35). The formula to calculate the best amount to borrow is the $1,050 tax you would save without borrowing, divided by the difference of 1 minus T. When you divide $1,050 by 0.65 you get $1,615.

Home Buyers Plan

If you want to buy a house within the next five years, consider taking a Home Buyers Plan (HBP) withdrawal from your RRSP. Increasing the size of your down payment reduces your interest costs. You might even avoid the need to pay premiums for CMHC mortgage default insurance. With an HBP you can withdraw $25,000 from your RRSP without tax deducted.

If you’re buying your house in 2015, make sure your RRSP contribution is at least 90 days before your HBP withdrawal.

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