Credit crunch hits homeowners

Banks quietly cut mortgage discounts as profits decline in debt turmoil

Garry Marr, Financial Post Published: Tuesday, November 13, 2007

The credit crisis in financial markets is now starting to hit Canadian homeowners right where they live with higher mortgage rates.

In the past four weeks, all of the major banks have quietly moved to cut the discount they provide on mortgages because their profits have dwindled as their borrowing costs have gone up.

Canadians now negotiating a variable rate mortgage can get .60 percentage points off of prime. Less than a month ago they were getting .90 percentage points off. With prime at 6.25%, it means the difference between a mortgage rate of 5.65% versus 5.35% which could mean an additional $12,000 of interest on an average Canadian home over 25 years.

"The banks are going to make their profits somewhere and that's what they are doing," said Vince Gaetano, vice-president of Monster Mortgage, a mortgage brokerage firm.

The move to sharply reduce discounts is not just limited to variable rate mortgages. The banks have also cut how much they are willing to lop off longer term mortgages, including the five-year closed mortgage which remains the most popular product in Canada.

Mr. Gaetano said rising rates in the mortgage market can be traced back to the crisis in the asset-backed commercial paper market where investors have ended up being stuck with $40-billion worth of paper they cannot redeem. Since the crisis, the yield on ABCP has risen from about 4.30% to 5.20% because of the increased risk, said Mr. Gaetano.

All short-term debt has been affected, including the banker's acceptance rate, which is based on what financial institutions charge each other for short-term loans. The BA rate is set in the market and has been rising.

"What the crisis has done is it has significantly reduced the spread between prime and the BA rate," said Joan Dal Bianco, vice-president of real estate secured lending with TD Canada Trust.

Ms. Dal Bianco said the spread between BA rate and prime had been about 165 basis points for half a decade and it has since shrunk to about half that. "We are all in the same boat in terms of the margin shrinkage," she said.

The lowering of the discount has nothing to do with any lack of confidence in residential mortgage debt, it is simply a question of the banks maintaining their profitability. Most estimates place the default ratio for Canadian residential mortgages at under .1%.

The BA rate started going up in August but the increase was not borne by consumers until around the second week of October. "We decided to move in October. Nobody wanted to pass it on to the consumer but by October we really had to," said Ms. Dal Bianco.

The decision means the average Canadian homeowner with a 25% down payment on a $308,543 home -- the average sale price over the first nine months of the year -- now faces a monthly payment of $1,432.76 based on a 5.65% rate. Before the ABCP crisis, that consumer would have received a 5.35% rate and been paying $1,392.35 monthly.

There's no break if you lock in your rate either. The spread between the banks' borrowing costs on a five-year mortgage and what they loan that money out for has also shrink. "It is sustained squeezing of the margins," said Ms. Dal Bianco.

The gap between the bank's borrowing costs and the rate it loans money to consumers on a five-year term is about 180 basis points. Two months ago it was about 140 basis points.

"Lenders need to figure out a way to keep their profitability up. Everybody feels good because they are getting a discount on the posted rate but they should look at how much their discount is these days," said one mortgage insurer. "This isn't an anti-bank story. Their cookie jars are a little emptier these days and they have to make it up."