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January 2, 2018 | Over

A best-selling Canadian author of 14 books on economic trends, real estate, the financial crisis, personal finance strategies, taxation and politics. Nationally-known speaker and lecturer on macroeconomics, the housing market and investment techniques. He is a licensed Investment Advisor with a fee-based, no-commission Toronto-based practice serving clients across Canada.

The dollar hit a glorious, brief 80 cents as the first trading day of the shiny new year dawned. The immediate reason: oil. It finally reached 60 bucks, and the black stuff is our biggest export. Oil’s going up because Iran’s in turmoil, and the OPECers are curbing production (to force oil up, duh).

Anyway, whatever reduces the price of a new Harley is good for the nation’s soul. But there’s more to note. The loonie jumped 7% during 2017. The country just created more jobs than in eight years. Corporate profits are running at double-digit levels. The banks alone make over $10 billion every 90 days. Canada led the G7 last year in growth. Government bond prices are going down and yields have popped higher.

So, yeah, this leads to one conclusion – likely confirmed by this Friday’s labour stats – rates are going up. Three times. Bank mortgages now at 3.25% will be at 4% by the end of 2018. That’s still cheap by long-term standards, but it’s almost double where they were in the storied Spring of 2017.

Those who believe the Bank of Canada will not move because Canadians pigged out on debt and levered up real estate when rates plunged are wrong. Over 90% of the time our bank follows the Fed, which jacked the cost of money four times in the last 12 months and will do so again three or four more in 2018. More in 2019. Then more in 2020. This is a fact of life everyone better get used to. The days of ultra-low rates and bloating houses are over.

Complicating it are two other realities. Almost half of all the existing mortgages in Canada come up for renewal during 2018, so most people will be refinancing at a higher rate. Second, of course, is the stress test – effectively preventing many homeowners from shopping around for a better rate. If they leave their existing lender, they’ll have to pass the test. To do so they must prove an income capable of easily carrying the loan at roughly 5% or their lender’s rate plus 2%, whichever’s higher. It’s a high bar to jump over for those who got into home ownership at 2.2%.

What should the strategy be, if you’re a renewer?

If you’ve got lots of equity and a healthy income then switching lenders might be a boffo idea. B20 reg changes will be throwing a big wet blanket over the entire mortgage business, at least for a while. What a great time to be negotiating the best possible deal with a lender hungry for more business and an enhanced market share. Of course if you’re afraid of failing the test and don’t move, expect to be plundered.

Second, lock in. The rate increase is not a blip. It won’t be truncated. Or short. This is the long-term normalization of the cost of money. No, we’re not going back to the decades-long average of 8% mortgages, but 6% doesn’t seem like a stretch.

Remember a $100,000 income and $100,000 down payment will get you a $694,000 house when mortgages are just under 3%. When loans move to 4%, that house shrinks to $606,000. At 6%, it gets you a $516,000 property. See how this works, kids? Houses went up when rates went down. Now we’re in reverse.

So, lock in.

But for how long? If we’re done with ridiculously cheap money and are looking at years of rates wafting higher, would it make sense to borrow on a 10-year basis?

The gnomes at RateSpy had an interesting piece on this a few days ago. Their conclusion: forget it. In the last 40 years there’s never been a 10-year period in which paying the premium for a 10-year loan saved you money over borrowing on a five-year basis.

But is it different this time? BMO, which is currently selling its 10-year product (in an environment filled with fear of rising rates – crafty), argues it might be. The bank is offering a decade-long commitment at about 3.5% – just a quarter point over the current fiver. So rates need only increase by about .6% for a borrower to do better by going super long.

But there are some disadvantages. Borrowers can’t get out of the loan for five years unless they sell the property. It doesn’t come with a line of credit (no Lambo for you). The allowed prepayment amount is less. And no 30-year amortization. After five years the mortgage becomes open (every mortgage does) so it can be paid off or refinanced at any time.

Rates will be one of the biggest stories in 2018. The impact on house sales and prices will be meaningful. The party’s over. Govern yourself accordingly.

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January 2nd, 2018

Posted In: The Greater Fool

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