To Lock or Not?
By Greg Williamson, President
Since our last commentary much has certainly happened. We have seen unprecedented rapid increases in the Canadian Dollar, we continue to see the US housing industry in a free-fall and the US mortgage industry is still reeling.
The question on the minds of all of our clients is, “What should I do?”
First, be careful about what you read in the papers. Always remembers that a newspaper’s primary concern is to sell newspapers – often times the stories that they report don’t tell the whole story at all. I recommend you still follow the news, but also ask your Professional Mortgage Planner to decipher what they report to you.
To properly examine and recommend what people should do with their mortgages what first needs to be explained is the current landscape – that being the fact that the US led global liquidity crisis has and will continue to significantly affect our Mortgage Markets.
Let me first explain what the liquidity crisis really is so you gain an understanding of why things are happening as they are:
Two years ago when the US interest rates were so low banks were pressured to come up with more creative and aggressive mortgage products that would be marketed to a higher risk individual at higher rates, thereby earning the investors higher spreads. This sounds all good, except two major things happened which lead to the mess we currently find ourselves in:
1. Interest rates rose 2. The products were largely ill conceived
The most common sales features of those ill-conceived Sub-Prime mortgages were a low introductory rate and little or no down payment. The extremely low “introductory” rate was to assist with comfortable payments to allow people to qualify and afford their new mortgage. To top it off, they often required little, no, or borrowed down payment and were lending to people who had less than perfect credit.
These products were sold to people with the plan that they would be able to purchase in an affordable manner to start, and in two years when their price was being reset they would refinance to a new amortization and lower rate thanks to the equity they built in their homes by then.
I often wonder if people ever asked “what if” during these sales pitches?
The “what if” entered the picture early this summer. The first of these introductory rate mortgages started to come up for their reset and realized that rates had increased higher than they could certainly afford and, more importantly, the refinance mortgage option was now gone.
Ask yourself, what would a person do when faced with an unmanageable increase in their mortgage payment, coupled with no equity left in their home – or worse, a mortgage that is higher than the value of their home? You guessed it…they’d walk away.
Hence, those early price reset people began the vicious spiral down. As more and more people walked away it caused the housing market and housing prices to drop even further – causing even more people to experience ownership of a mortgage that was higher than the value of their home. And so on, and so on…
You might ask, “Why has this crisis caused global rates and mortgage banking to be so affected?”
The global market is being affected right now because the global market was heavily invested in these American mortgage pools. The current crisis continues on for two reasons: The first is because many investors feel they were lied to about the quality of the mortgage assets they were investing in, and as this mess is still on-going, most of the investors have a trust issue and are refusing to invest.
As you would expect, no investment dollars means that banks have to look elsewhere for money to lend. In this case this case, demand for mortgage money to lend is high and supply is tight. Classic economic theory dictates that in cases like this, prices go up. This has happened. Alas, if the banks cost of getting money to lend is higher, you can bet that they will charge their customers more. Now you can see why mortgage rates are higher right now than the greater economy indicates they should be.
What has to happen, then?
First, we have to see the end of the “Mortgage Meltdown”. Experts suggest we are only now at the midpoint and are looking at a minimum of 6 – 9 more months before we reach the end of this ride.
Secondly, banks and investors must continue to price in the effects of this crisis so there is not a hard crash landing at the end.
Lastly, the banks and mortgage investment companies need to rebuild trust with their investors so that they will put the much needed money back into the markets.
So, what to do?
If you can handle the stress of being in a variable rate mortgage through this crisis, then do so, and wait this out. We predict variable rates to stay flat or even have a .25% drop in 2008. We are of the opinion that this is the best strategy.
If you are convinced you need to lock in your mortgage rate, then speak to your Mortgage Planner and ask them to shop around for a new lender. All indications seem to show that the liquidity crisis is also causing banks to charge higher early renewal rates than they have in the past due to the aforementioned increase in the cost of funds as well as to capture some much needed margins.
On the flip side of this, banks are and always will be aggressive in getting new business and market share and so will be even more aggressive.
This will also allow you to look at using the equity in your home for a solid debt repositioning strategy or a tax deductible mortgage strategy. Again, your Mortgage Planner can advise you regarding your options.
