Broker or Bank - The Borrower's Dilemma

The differential advantage to a borrower for using a broker is NOT the fact that the broker sends a mortgage deal to a non bank lender, it is the goal that a broker will obtain the best available deal for the borrower, from a bank or a non bank lender.

Brokers should have no loyalty to a particular lender, although it would be disingenuous to suggest that bonusing arrangements have no impact on mortgage placements with different lenders.

Also, commission rates vary from one lender to another, and from one product to another, which means that some brokers measure their income from a deal before they figure out what the best deal for the borrower could be.

These things mean that brokers are inherently in a conflict of interest with a prime "A" borrower because the placement of the loan can have a huge impact on how much the A broker will earn.

In British Columbia the Financial Institutions Commission recognises the potential for conflict of interest, and requires brokers to sign a disclosure of the conflict of interest, as well as a disclosure form which details any fees paid by the borrower directly to the broker. However, fees paid by the lenders to a broker are not disclosed in any required forms in BC, something that probably should be remedied in due course.

This is not only an issue for mortgage brokers. All consultants who make their living by being paid for the placement of products or services to their clients are also generally in a conflict of interest, and are to some degree driven to sell products based on what they earn from doing so. So the main difference with mortgage brokers is that the service we sell is fundamentally different in that we represent vendors of the single largest expense in most of our clients' lives - their mortgage.

Undisclosed differences in payments by different vendors of loans drives some brokers to make recommendations based almost entirely on how much money they will make by placing the deal with one lender or another.

The thing that protects the public from being abused by the conflict of interest is that the mortgage brokerage industry is incredibly competitive - any broker who acted contrary to the client's best interest would probably soon find himself out of business with no clients.

It is one of the distinctions that separate private loan brokers from A lender brokers. When someone borrows money from a private lender through a broker there is no failure to disclose. All brokers fees, appraisals, inspections, etc. are paid for directly by the borrower and the borrower is fully aware of any and all out of pocket costs, which include all payments made to the brokers.

So while most "A" brokers tell you that you will pay no fees for their services, what they don't tell you is that the method by which they earn their fees may be inherently contrary to the borrower's best interest.

At the very least the rules of the industry should require that these fees be fully disclosed, so that the borrower may make a fully informed decision about the relative merit of the advice he or she is receiving.

As for the conflict of interest a borrower encounters by going directly to a bank - there is no conflict of interest: the bank employee represents the best interests of the bank, only the bank and always the bank.

So a borrower has to make the best of two choices, one with the potential for a conflict of interest (the broker) or the one with no conflict of interest (the banker) since the bank always acts in its own self interest.

I am attaching the following article from Merix completely because it provides a comprehensive explanation of how mortgage insurance actually works for most consumers.

Clearly, based on what Merix is saying, the changes to government policy regarding mortgage insurance may have a significant effect on mortgage investors, if they are relying on Home Lines of Credit secured by mortgage insurance, whether provided by CMHC or by a private insurer.

However, most mortgage and MIC investors who are using leveraged funds are not borrowing money under the terms of insurance mortgages, nor do they tend to use extremely high ratio mortgages for investment purposes, so the change may not actually have as big an impact as one might otherwise imagine.

MERIX Comments on Changes to Government Guaranteed Mortgages

There has been lots of discussion in the news about the recent changes to government guaranteed mortgages announced by the Minister of Finance.

However we believe the majority of Canadians do not understand what exactly it means to remove the “government guarantee” from some of these lending programs.

We’ll explain…

Many Canadians generally understand how mortgage insurance works. We’re not talking about mortgage life and critical illness insurance, we’re talking about mortgage default insurance. This is the premium that is applied to your mortgage amount and is paid to a mortgage insurer, who in turn agrees to insure your mortgage with your lender in the event you default. In other words, it is protection for the lender incase their customer cannot make their payments. This is a mandatory insurance for mortgages higher than 80% of the home value.

Well that’s great, but what happens if a lot of people all of a sudden can’t make their payments and the insurer who is supposed to protect the lender is unable to cover their insurance obligations?

Enter the government guarantee.

The Canadian government will guarantee up to 90% of the mortgage amount against insurer default. So, this is security for the lender in the event the insurer defaults. This Government Guarantee is in place for CMHC (Crown Corporation) as well as the private insurers, such as Genworth Financial Canada.

The government guarantee is also a criterion for high ratio loans to be sold into the Canada Mortgage Bond program, which is a relatively new cost-effective funding source for banks and mortgage lending companies. These Bonds are bought up by investors all around the world due to their higher yield than Government of Canada Bonds combined with their “government guarantee”.

So what has changed?

Well, the Finance Minister looked to our southerly neighbours as well as across the pond and noticed some pretty dire scenarios which begged the question: Are we guaranteeing mortgages that are a little too risky? After an analysis of the mortgages that fall within their guarantee, recent trends, and industry consultations, the Minister of Finance decided to cease guaranteeing high ratio mortgages with the following characteristics:
- LTV ratios in excess of 95%
- Amortizations in excess of 35 years
- Non-amortizing mortgages (Interest-Only Mortgages).
- Applications where the beacon score of both borrowers is less than 620.

How does this affect me?

If you are a current homeowner, who is happy in your home and have no intentions of moving in the near future than this probably doesn’t affect you. However if you are a prospective homebuyer, looking for 100% financing and a 40 year amortization then your financing options are becoming a little more limited. Most of the big chartered Banks and many lenders have already pulled the above products. Other lenders, such as MERIX are offering these products until October 13, 2008 (please speak with your mortgage originator concerning rules around this deadline).

Let’s take a closer look at the 40 year amortization phenomenon:

Why is it appealing when borrowers know they are paying many thousands of dollars in interest over the life of their mortgage? Well there are a couple of predominant reasons:

New homeowners are increasingly concerned more with their payment amount than the house price or the interest cost over the life of the mortgage. It’s a decision made largely on cashflow.
The vast majority of people who take 40 year amortizations actually qualify for 25 year amortizations but choose the former and accelerate their payments, which reduce their amortization to 32 years. Registering their mortgage with a 40-year amortization helps protect them in the future should they need to decrease their payment.

From a purely mathematical perspective, according to the Ministry of Finance:
“Reducing amortization from 40 years to 35 years on a mortgage loan of $200,000 with a 6 per cent interest rate results in a $41 increase in a borrower’s monthly payment, but the borrower will save $49,000 in interest payments.”

Looking ahead…

If the decision to take 40 year amortizations is based on cashflow, then we’d suggest $41 per month on its own will not cause any major disruptions in the housing market. The reality is that new mortgagors will have to spend a little more in their monthly mortgage obligations but the impact to the housing market will be isolated to those who needed the 40 year amortizations and 100% financing to qualify for their mortgage. As a replacement for 100% financing, we may see the increase in popularity of Cashback mortgages once again. The 100% financing programs have all but made CashBack offers obsolete, however they may be a decent option for some people once again - even if the interest rate is higher.

In the short term, we may see a small spike in homebuying and refinance activity as people try to accelerate their timelines in order to take advantage of these fleeting offers. This may keep the market relatively strong through 2008. In the medium to long term, we don’t expect these changes to have much of an impact to the housing market. 35 year amortizations are still available and for that matter 40 year amortizations will still be available by some lenders, such as MERIX, for those customers who have the minimum 20% down payment for conventional financing.

For more information about 40 year amortizations, we encourage you to read “Why 40 Year Mortgages Aren’t 40 Years Long”, by Peter Vukanovich, President, Genworth Financial Canada. This article can be found here: http://www.genworth.ca/mi/eng/downloads/HT_April_2008.pdf


Sincerely,

The MERIX Financial Team
And Your Mortgage Originator





By partnering with professional mortgage originators, our customers can be confident they are receiving the knowledge they require to make the right decision. And this is the advantage of dealing with MERIX Financial.

MERIX FINANCIAL KNOWLEDGE IS ADVANTAGE

40 Year Amortizations and Zero Down Mortgages

I've had a number of my clients inquire recently about the 40 year amortization mortgage and zero down mortgages, and what the recent news about changes in government policy and mortgage insurance mean in the context of current real estate trends, particularly in BC and Alberta.

The first thing to remember is that the changes to the rules were relatively minor, reducing maximum amortizations only five years, from 40 to 35 years, and from 100% financing to 95% financing. While the changes do represent a significant policy initiative by the feds, it is more what they aren't doing rather than what they are doing that is significant to most investors in real estate.

So far the federal response to the credit crunch in the United States markets has been remarkably measured, considering the near hysteria across the border. There may still be some serious shakeups in the Canadian banking industry as a spill-over from the US problems, with Canadian chartered bank CIBC appearing to be in some potential trouble, although I suspect that CIBC will survive as an independant bank even after all of this is over.

The main thing that investors should consider is that real estate markets go up and down, but mostly they go up over the long run. In the short run this is not much comfort, especially for anyone committed to a property they have purchased at the top of the most recent hot markets. The changes to the purchase rules by the insurance companies, stricter credit rules or more stringent application of existing credit rule, may all have some impact on the markets by reducing market demand somewhat.

But my bet is that the reduction in market demand for housing will be "normal" in the Canadian sense of that word. In other words, be patient and the real estate market will eventually reward your patience.

If you panic, then you probably will get hurt, just as when you panic when swimming in the ocean.

If you are looking to acquire a property with nothing down, it might just be a little more difficult than previously, but that may also be a good thing if it means that people aren't going to get stuck with property they really can't afford.

Real Estate Outlook and Interest Rates

The Bank of Canada yesterday left interest rates alone. Based on the performance of the real estate markets in British Columbia currently they probably should have done exactly that... BUT! in the ROC property values are in the dumper and the economy is slowing rather quickly! The need to keep inflation under control is what is balancing the demands of the economy for liquidity, and with the rapid run up in the cost of energy and other commodities over the past couple of years, who can argue that inflation isn't a problem.

So, we have stagflation.... something totally familiar to those of us who survived the late 1970's only to go in to the crash of 1981. Anyone who lived through the crazy inflation of the late 1970's never wants the government to allow that level of devaluation of the monetary system to occur again.

So it sound like I'm endorsing the current policy by the BOC of doing nothing. Hmm... maybe I am, after all. It could be worse, we could have inflation threatening double digit inflation, or perhaps US style declines in house pricing. As it is, what we have is a bit of the economic flu, with a touch of stomach upset.

Take a couple of pills, roll over, and sleep until morning (or until 2009). Things should look better by the later half of 2009.

In the meantime, invest in mortgages and MIC investments to protect your income and your capital, and leave the volatility of the real estate markets to someone else.

Big Brother is watching YOU!

FINTRAC, our national financial transaction watchdog, introduced new regulations governing Real Estate Agents, which took effect Monday, require realtors to get identification and record the name, address, date of birth and occupation of buyers, sellers and any individual or corporation that contributes financially to a real estate transaction.

The government claims that all of these regulations tracking the flow of money are about getting on top of organized crime and terrorist organizations, and preventing the laundering of the proceeds of either type of crime.

I say its all about income taxes and tracking the flow of money, in an attempt to get control of the "grey", ie: underground economy. Over the past twenty five years, with the radical increase in various types of taxes there are an ever increasing numbers of individuals who are actively hiding their income and attempting to become invisible to CRA.

So if the government is having a hard time tracking all the various ways of masking income, they then have a need to figure out how to track the proceeds of that income. Thus, FINTRACK which gives the government enormous powers of investigation, and recruits everyone who works in the financial services industry, and now the real estate industry, into helping to enforce taxes on those who would try to avoid paying them.

Now, don't get me wrong. I think that everyone should pay their fair share of taxes, after all, we all use government services when we need to and nothing justifies someone trying to get out of their obligation, so my concern is not about the need to assess and then to collect outstanding taxes.

Rather, my concern is that governments have been using the terror attack on the World Trade Centre in 2002 as an excuse to increasingly invade what used to be considered private information and confidentiality. Not everyone is comfortable with the government having access to every nook and cranny of our private lives. Internet invasions, email scrutiny, etc. have all increased by the government in the past five years, and the agents of the government have also increased their surveilance of financial transactions.

It used to be that cash was a time honored way to pay for things. I remember in the 1970's paying the down payment for a house in cash, literally in one hundred dollar bills. Today it would be assumed that those were illegal or illegitimately obtained. In my cash the one hundred dollar bills were saved from years of doing yard work as a teenager, and yes I did file income taxes even as a teen.

My point really is that Big Brother really is watching you, and they have just increased their army of eyes by the number of realtors in the country. Should we be concerned? You tell me.