Is the real question about the rate?

by Mario Cloutier, Head of Broker Sales

The burning question In the mortgage industry has been about the substantial rate increases of the past 18 months. You're meeting clients daily with the same one question: when are rates going down again? Are we better off getting a 1 year, a 3 year or a 5 year? Fixed or variable? Are we going to qualify for the mortgage amount that we want, that we need?

You're providing advice and strategy to the best of your ability with the information available to you. And there is a lot of information available. Depending on your source of information, it could be as early as September 2023 to as late as January 2025, that rates could go down anywhere from 50 basis points (-0.50%) to 200 basis points (-2%). Some are even predicting the rates will go up before they go down again. The truth may very well lie somewhere in the middle, but there is also a strong possibility that no one has the definite answer including the Bank of Canada or the Federal Reserve.

I'm proposing a different perspective on the matter. We like to believe that, potentially, Canadian consumers are far more concerned about the cost of life than about rising rates. Rising rates are one effect of the current situation. Could the real question be how can we continue to afford our way of life with the current inflation and the fact that our income is not rising along with it?

In the Spring Financial Health Survey conducted by Manulife Bank, 81% of Canadians surveyed believe there is an affordability crisis in Canada. Basically, many are struggling to keep up with grocery costs, leisure and travel, not to mention large mortgage payments. Why should mortgage payments and rising rates be tagged separately from the "big picture"?

More than 65% are stating expenses are growing faster than their income. They also told us they could plan better for retirement if they could manage their financial priorities, using the sound advice of cash-flow managers. I have been saying for a long time the key for the broker industry is to develop and elevate the advice-driven value proposition of cash and debt flow management.

In financial planning, that is intended to build wealth and plan for retirement, there is a general principle to diversify investment risk. Diversification is defined by the spread of any investment towards different asset classes. It helps diversify the risk just as much as the reward and the return on investment. If an asset class is riskier, the return on investment might potentially be greater, but the risk of losing more is also quite present.  Hence the need to have some safer assets that may offer fixed rates of returns bonds, GIC and some dividend producing stocks. These assets don't provide that much return but keeps the nest egg safe in order to secure a minimum income at retirement. This principle of diversification is embedded in the investment world. I am going to suggest this could potentially be the solution to the current concerns with rising interest rates, high inflation and the affordability crisis in general.

Another interesting statistic from the Spring Financial Health Survey is while only 44% claim to currently own a property with a mortgage, 66% of consumers surveyed said they carry a balance on their credit cards. This statement is somewhat concerning given the rates on credit cards can range from 9% to 28% interest and the debt associated with this type of credit instrument is not providing wealth or aiming to improve a person's overall cashflow position. Perhaps we have this backwards?  As an advisor for the client's net worth and with the intentions of working in their best interest, should we not examine the problem with it's full scope? Shouldn't carrying a credit balance (which no one intentionally wants) be a key indicator that a client needs help with managing their cash-flow? How can we apply this to the mortgage and real estate part of a consumer's portfolio?

As we discussed the need to not have all our "eggs in one basket" in the investment world, the same truth could and should be applied to interest rates in mortgages.  While no one can assess for sure when rates are going to go down, we can be certain they will go down eventually. The level of inflation has not hit the 5% mark since the record year of 1991. Mortgage interest rates have not risen over the 5% mark since the turn of the century. 

We are going to suggest that there should be no rush in "fixing" mortgage rates in the current market. Canadians are stating clearly they have concern about the affordability of household expenses, not about mortgage rates. Their concerns are being expressed by inquiries like, “when will the rates go back down?” What they are really asking is “when can I expect to make smaller payments for my mortgage?” What if the solution was to make minimal payments, interest only, until the dust settles? It is a big commitment to fix your payment for the next three to five years and can imply a lot of reflection and certainty. It also requires a lot of information that may potentially be missing at this time. If the only certainty is that rates are going to go down, why not wait for it to happen?

Furthermore, when it is time to "fix" a mortgage, why not spread the risk by selecting more than one fixed term? As mentioned, we diversify our investment risk but often put our entire mortgage into one term. Fixed, typically for five years, and unbreakable unless we want to incur heavy financial penalties.

In this time of uncertainty there is value in "not fixing" everything into one term for 3 or 5 years, and play the odds of potential rate decreases in the years to come. A traditional mortgage only permits one fixed or variable rate term. This is where unique solutions such as Manulife One are different; we focus on cash-flow and interest costs rather than interest rates. We can provide an open-variable rate with up to five fixed-rate diversified terms (from one to five years), allowing you and your clients to diversify their mortgage. This reduces the risk of interest rates going up and creates more flexibility to reduce mortgage costs and payments when rates go down. For many Canadians, their home may be the biggest investment they own. Shouldn't paying for that investment be diversified like every other aspect of their overall financial plan?

Now, of course every situation is different, every cash-flow scenario may imply a more thorough analysis. In this era where consumers are looking, more than ever, for advice-driven solutions rather than the best rate, there's a great opportunity for mortgage professionals like you to make a significant contribution to the most important decision of your clients' financial lives.

The last thing we should be doing is forcing homeowners to make a mortgage decision today that will impact them for the next five years.