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New Mortgage to Reward Savers
HSBC Bank Canada has launched a mortgage option for homeowners looking to pay down their mortgage faster without having to forego the security and liquidity of maintaining a cash reserve in their savings account.
The new HSBC Smart Savers Mortgage enables homeowners to link their savings accounts to their mortgage and use the balances in these accounts to ‘offset’ or lower the interest rate on the mortgage. As the actual monthly payment remains the same, this feature will allow more of each monthly mortgage payment to be applied directly to paying down the mortgage principal and help the homeowner become mortgage-free faster.
This type of mortgage has already been pioneered by HSBC in several other international markets such as the UK and Hong Kong with great success, HSBC Bank Canada says.
“In times of economic uncertainty many homeowners have traditionally looked for ways to pay down their mortgage more quickly, but have held off because of the competing instinct to hold on to strong cash reserves as a fund for emergencies or other future uses,” says Linda Seymour, senior vp, personal financial services, HSBC Bank Canada. “This new deposit linked HSBC Smart Savers Mortgage will allow them to do both.”
As interest rates charged on mortgages have traditionally been higher than interest rates offered in savings accounts, an additional benefit to users of the HSBC Smart Savers Mortgage program would be that they would in effect be generating an interest “premium” over what they would receive on their regular savings.
For example, a home owner with a HSBC Smart Savers Mortgage with a balance of $300,000 at an annual percentage rate (APR) of 4.59% (for a 5-year fixed term, renewed at the same rate, amortized over 25 years) who links $45,000 in deposits throughout the life of the mortgage, effectively reduces their interest rate to 3.9% APR.
While the monthly payments stay the same throughout the term of the mortgage, more money goes towards the principal. In this example, the amount of deposits equals 15% of the mortgage balance, so the interest rate is reduced by the same 15%. This allows the home to be paid off more than three years faster than with a traditional mortgage and will save nearly $50,000 in interest over the life of the loan.
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Interest Rates Cut
Canada's central bank cut its trendsetting interest rate by a quarter point to a record-low 0.25 percent and said it will likely stay there through June 2010.The Bank of Canada said Tuesday the global recession has intensified and it expects the recession in Canada will be deeper than anticipated.
The bank said it is conditional on inflation but they expect the rate to remain at its current level until the end of the second quarter of 2010. It said it is appropriate to provide more explicit guidance than is usual regarding its future path so as to influence rates at longer maturities.
The central bank said the economy will shrink by three percent this year, almost three times as much as the 1.2 percent it forecast as early as last January.
And it said the economy won't rebound nearly as strongly as it thought, saying any recovery won't start until the last three months of the year and growth next year will be more muted, at 2.5 percent instead of the 3.8 percent previously expected.
"In an environment of continued high uncertainty, the global recession has intensified," the bank said in its statement.
"Deteriorating credit conditions have spread quickly through trade, financial, and confidence channels. While more aggressive monetary and fiscal policy actions are under way across the G20, measures to stabilize the global financial system have taken longer than expected to enact."
Mark Carney, the head of Canada's central bank, has said that the success of America's bank bailout plan is crucial to economic recovery. Canada has avoided government bailouts and has not experienced the failure of any major financial institution. There has been no crippling mortgage meltdown or banking crisis north of the border where the financial sector is dominated by five large banks.
But Canada and the U.S. have the largest trading relationship in the world. The financial crisis and the global sell-off of commodities have hit Canada hard since last fall. Alberta's once-booming oil sands sector has cooled as every major company has scrapped or delayed some expansion plans.
Canada lost a record 273,300 jobs in the first three months of the year.
The latest interest rate cut means the bank has cut 4.25 percentage points off the overnight rate since it began the current easing policy in December 2007.
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The continued drop in rates has revived the ongoing debate all homeowners face over whether to choose a variable or fixed mortgage rate.With interest rates so low, a lot of people are spending a whole lot of time worrying about whether or not to lock in their mortgage payments.
The rate-watching game has been a little more uncertain lately as rates have reached a point where they seem to have little room left to move.
Overall, mortgage rates have been on the decline for years now. As a result, those Canadians who opted for variable mortgages, where the mortgage rate fluctuates with any changes in prevailing interest rates, have clearly come out ahead.
Not that they're in the majority. Statistics show that only about 20 per cent of Canadians homeowners opt for a floating rate.
The big move into variable mortgages has really only come in the past few years, with many institutions pushing floating products that allow you to lock in a rate at any time during the term of your mortgage. If you're one of these astute buyers, you'll want to hang on as long as your term allows since lenders are actually losing money on your loan right now.
But, given current bargain basement borrowing costs, will this be the way to go from here on out?
Currently, the Bank of Canada's trend-setting overnight rate is at 0.5 per cent, and Canadian banks' prime rate is at 2.5 per cent. Most major financial institutions are now charging good customers roughly 3.5 per cent for a one-year closed rate and closer to 4.5 per cent for a five-year term. On the variable side, you're looking at prime plus 0.8 percentage points, which today translates into 3.3 per cent for a five-year term.
So, if you're buying a house or simply coming up for renewal, which is it to be? Fixed or variable?
Based on several studies going back as far back as 1950, York University professor Moshe Arye Milevsky has found that homebuyers would have been better off, roughly 88 per cent of the time, financing their home with a variable rather a fixed rate mortgage.
If you don't mind a few ups and downs, the benefits of variable-rate mortgages are very compelling. But a lot has changed since those studies were first done and subsequently updated.For one thing, lenders have been eliminating the discounts that were once prevalent on many variable mortgages. In the past, rates were calculated as prime less a premium, often as much 0.9 percentage points. But you won't anything like that today. And, although it varies from city to city, housing prices are falling, thus raising the spectre of negative equity for some homeowners.
More importantly, if you look at rates right now, the difference between the two options just isn't that sharp. Right now, you might pay as little as 1 per cent more to lock in a long-term rate.
Economists expect rates to remain low and even decline slightly for another year or so, then rise by as much as 3 per cent as a recovering economy produces an increase in inflation.
This has prompted observers like Canadian Imperial Bank of Commerce's chief economist Benjamin Tal to suggest that while variable rate mortgages might still prove attractive for a bit longer, the threat of interest rates rising makes in locking in a fixed rate much more appealing than it once was.
With some variable mortgages, as rates fluctuate, so does the amount of your mortgage payments. Or, with set payment amounts, the portion of the payment that covers your mortgage principal will vary.
In a falling-rate environment, this means you'll pay down more principal and pay less interest. But if rates go up, your principal payments will shrink and it may take you longer to pay off your home. For every half point interest rate increase, the monthly payment on a typical mortgage of $200,000 jumps roughly $80 - or more than $900 a year.
The right mortgage decision is really a matter of your attitude towards risk and your need for certainty. If the prime rate does drop a bit further and you're working with a variable rate, you'll see the decrease in your mortgage rate almost immediately.
On the other hand, if you lose sleep worrying about the impact of every blip in rates on your monthly budget, then a fixed rate mortgage is for you.
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Should you refinance your mortgage?
With interest rates low, Canadians are thinking about refinancing their mortgages. Here's how to tell if it's worth it.
Equity markets are see-sawing back and forth and yet there is an opportunity to build wealth in a low interest rate environment.
Where do interest rates touch most Canadians? Canadian mortgages. As rates have inched lower and lower, refinancing your existing mortgage becomes more and more appealing. Typically, the decision rests on the trade-off between how much it will cost to break out of the current mortgage and how much you would save in interest payments going forward.
Let us discuss an example where there is $100,000 outstanding on a locked-in fixed rate mortgage set up in January 2008 at six per cent for a five-year term. With 45 months still remaining on the term and posted rates for four-year fixed rate mortgages now at 4.4 per cent seems like a savings of 1.6 per cent!
However, to break the existing mortgage you would need to pay the greater of three months interest or the interest rate differential (IRD).
A back-of-the envelope calculation shows that three months interest would be $1,500, whereas the IRD would be $6,000. So the cost of breaking the mortgage would be $6,000. For arguments sake, let's assume you went ahead with this, and locked in for that four-year term at 4.4 per cent.
The interest saving over the next four years on $106,000 would be $5,176. That's less than what it cost to break the mortgage. It doesn't make sense in this scenario. It might make sense if you went from a 6 per cent fixed rate to a variable rate at prime + 0.8 per cent (Current 3.3 per cent). This time, you would be taking on the potential risk of an increase in interest rates over the course of the remaining four years.
What if you already have a variable rate mortgage? If you began the year with a $100,000 mortgage at Prime + 0.8 per cent and 25-year amortization, it would require payments of $517 each month over a five-year term. But then the Bank of Canada cut its benchmark lending rate by 50 basis points to 0.5 per cent - the lowest ever.
The savings on interest would mean that you could consider lowering your monthly payment to $490 a month. That's a saving of $27 a month. Big deal, right? Actually it equates to $2,400 interest savings over the five year term assuming rates hold steady. Don't lower your payments. Use the $27 savings in interest rate to reduce your principal by an additional $1764 over the five years.And the Bank of Canada has left itself open to further easing which means we could see the rate drop to 0.25 per cent on April 23. Those savings could get even bigger!
Alternately, you could use this saving to jump-start your Tax Free Savings Account or contribute into your RSP and link to a Systemic investment plan of balanced mutual funds.
There's another way to save on your mortgage payments. Simply increasing the frequency of your payments will reduce your interest payments over the life of the mortgage. You'll also be rid of it sooner.
Let's take an example of a $200,000 mortgage at 4.5 per cent (fixed rate) and 25 years amortization.
Now compare the monthly payment to the weekly rapid payment. By converting your monthly payment to weekly rapid, you benefit from sneaking in an additional four weeks of mortgage payments each year. Over the life of the mortgage you'll shave four years of its life and keep more than $21,000 in your pocket.
Taking care of your mortgage first helps you ignore the wild swings we're seeing in the markets these days. Next week I'll tell you how your portfolio can benefit from this low interest rate environment - in spite of the market volatility.
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