Consequences of Low Interest Rates and

the State of Our Real Estate Market 
 

After a decade of prosperous times, the Toronto Real Estate market last fall began to soften and the sales activity tapered dramatically in the last quarter of 2008. The real estate market meltdown was a global phenomenon. The recession had hit home and talks of a depression began to emerge.

Most buyers decided to sit on the sidelines and play the wait and see game.  Understandably buyers were exercising extreme caution and were quite jittery about making a decision. The media wasn’t helping matters – the level of negativity was unparalleled with the amount of doom and gloom being broadcasted.

Sellers who had committed to another purchase were facing dire consequences. They were going to either have to offer very attractive, reduced prices or possibly consider renting their home until the market conditions improved (if that was an option at all).

Prices started to fall (for the first time in a decade) and interest rates were being reduced continually to help stimulate activity. In both November and December the market was virtually at a stand still as there was very limited sales activity. January and February, all things considered were reasonable by way of activity given the economic conditions and considering this isn’t traditionally the peak time for the real estate market.

By March, the buyers seemingly could not resist the combination of low interest rates (variable rate mortgages hovering around 3.25% and 5 year fixed mortgages as low as 3.75%) coupled with the more realistically priced homes, subsequently sales started to soar. In particular low to mid level priced homes were seeing a heightened amount of activity.

At the time of writing this article, I am pleasantly surprised by the turnaround witnessed thus far in the spring market. We at Team McDadi have been extremely busy which is very encouraging. 
 

Mortgage Talk

It is important for sellers to understand some of the issues I have seen surface with these exceptionally low interest rates.

If you are obtaining a mortgage, you are fortunate to be obtaining some truly historically low interest rates. The decision between taking a variable rate mortgage versus a fixed rate mortgage should be evaluated with your mortgage consultant and/or your realtor to assess the pros and cons of each option. Be mindful although rates are exceptionally low, lenders are definitely exercising more caution with their lending policies.

If you are selling your home, PLEASE, PLEASE, PLEASE, be sure to know what your mortgage discharge penalty will be for breaking your mortgage prematurely (assuming you are not porting your mortgage). The banks will charge a fee which is the greater of either a three month interest penalty or the interest rate differential if you break your mortgage before the maturity date.

In the past, the three month interest penalty was typically used to calculate your cost. Because interest rates have dropped significantly, the interest rate differential is now frequently being employed to determine the borrower’s penalty. 
 

Interest rate differential is defined as the difference in the interest rate charged on your mortgage verses the current existing mortgage rates. If for example a borrower is currently paying 6.0 % interest on their home mortgage and the current rate is 3.5% the difference (6.0% - 3.5%) = 2.5%. This 2.5% will be charged for the months remaining on your mortgage. To illustrate, if you are carrying a $400,000 mortgage at 6.0% your monthly payment is approx $2,559. If the current rates are 3.5% the payments would be $1,997, the difference being $562.00 / month. If you have 48 months remaining on your mortgage, the penalty would be $562 x 48 = $26,976. (These figures are based on mortgages amortized over 25 years).

These numbers as witnessed in the illustration above can be staggering and the lenders unfortunately are not easing up on these charges.

One of our sellers sold their home 3-4 months ago and the lender had indicated their penalty would be approx $10,000 at the time of the sale. They found out a few weeks prior to closing, the penalty (due to further reduced rates) had increased to approx. $27,000. This came as an incredible shock to the seller. Unfortunately the client was not in a position to pay this penalty and the bank would not negotiate this fee. The deal did not close. 
 

There are other clients I know that have been assessed in excess of $30,000 to $40,000 in penalties to break their mortgage. This to me is totally outrageous. These lenders are truly taking advantage of consumers who in many cases are in a very difficult predicament. Interest rate differential was implemented by lenders to ensure a client didn’t break his/her mortgage prematurely to take advantage of lower market rates. Since the borrower made the decision to take a longer term mortgage this penalty basically washes or negates any savings that may accrue from breaking ones mortgage and going to another lender offering lower rates. I do, however, believe given that many sellers are being forced to sell because of true financial hardship being endured and as a result this excessive charge is crippling them financially.

The lesson learned is, please know in advance what all your closing/transactional costs will be before you enter into any agreement of purchase or sale.

Of course, if you port (transfer) your mortgage to another property, you will only be penalized on the portion of the mortgage you discharged. For example, if you had a

$400,000 mortgage and were carrying a $300,000 mortgage over to your new home, the penalty would only be assessed on the $100,000 mortgage you discharged. 
 

As a buyer this is now an opportune time to take advantage of historically low rates and sellers who are being more realistic with their expectations. As a seller, the market is becoming more vibrant and homes are starting to once again sell. However, it is important to be competitive with your pricing in today’s market place.

Although the market is changing and will continue to do so, this represents opportunities for buyers and sellers alike. It is extremely important to be informed as a consumer so that you can make good, sound educated choices during these most interesting of times. 
 

If you have any real estate related questions please contact Sam at 905-270-2000.