Analyzing Past Bank of Canada Rate Increases

BMO Capital Markets recently made some interesting observations about the Bank of Canada rate hike tendencies.

Despite a limited sample size, BMO listed the following common traits from prior rate increase cycles:

• Bank of Canada (BoC) rate hikes come in “clusters, moving across a minimum of two consecutive announcement dates. (If this holds true, the BoC will raise rates again on July 20.)
• 84% of the past 25 rate increases have been 25 basis points
• The BoC has often paused its rate hikes during past tightening cycles--sometimes more than once in a given cycle
• The BoC has shown it will tighten even with core CPI inflation below its 2% target (That’s largely because the BoC tries to anticipate inflation and because it takes roughly a year or more for rate hikes to work through the economy.)
• Rates rose an average of 200 basis points over 18 months in the past four cycles

(Chart via BMO Capital Markets, Author: Michael Gregory, CFA, Senior Economist)

BMO says the Bank of Canada typically sets policy after heavy consideration of five “C’s:”

1. Core CPI (inflation)
2. Canadian dollar
3. Commodities
4. Cross-border exports (to the U.S.)
5. Crises (economic, financial, or geopolitical)

That last “C” happens to be a factor today, courtesy of the European debt crisis. Nonetheless, BMO says: “We judge the Bank’s scale will eventually tip to the domestic data side, and the new tightening cycle will toe the stylized line.”

In other words, BMO expects concerns about European debt to fade at some point, with the BoC continuing its path to more normalized (higher) interest rates.

Maximizing additional payments

Additional payments in your budget:
It sounds like a great idea to make additional lump-sum payments annually or at the time of renewal, but you my be asking where does this money come from? Reworking your budget to set aside funds in a savings account is an effective strategy. Automatically pay into an account before you even begin to manage your budget, you wont even notice its absence.

Bonus time may have just come or is coming:
With the end of the year just past or your tax returns coming. Whether a set amount or an unknown windfall at this time, a bonus or tax return can often lead to, 'should I pay down my mortgage or go on that trip I've always wanted'? You have to really sit down and think about your overall situation. Paying down your mortgage is always a great option.

Increase your payment amount:
It may take some adjusting to work it into your budget, but increasing your monthly payment amount can save you thousands of dollars in interest over the duration of your mortgage and reduce the life of your mortgage by several years.

Increase the frequency of your payments:
While the most common payment plan is monthly, you may be better off making smaller payments more frequently. In this way you could reduce the amount of interest you pay and reduce your principal more quickly.

Pay more when you can:
If you chose a mortgage that allows you to make contributions outside of your regular payment date, taking advantage of it whenever you can offers considerable savings. You contribution goes directly towards your outstanding principal so your mortgage is immediately reduced by the full amount.

New mortgage rules simplified

There's still some confusion so this should help clear it up a bit:

1. VRM (variable rate mortgage) and fixed mortgage terms less than 5 years are now qualified on the bank posted rate when the LTV is 80% or higher on a purchase or refinance. Today this rate is 6.25%.
If you are taking a five year fixed rate or greater, the qualifying rate is the contract rate. Today around 4.5%.

2. Minimum down payment for rental units is now 20%.

3. Maximum LTV (loan to value) is now 90% on refinances and 85% for stated income (can’t prove income).

4. BFS (business for self) are required to prove their income after year 3 of business when using CMHC insurance for their mortgage. Genworth has not yet emulated this restriction.

5. Realtors, mortgage brokers and commissioned BFS must prove their income with NOA’s (notice of assessment) or use high ratio (CMHC or Genworth) and pay a premium.

HST

The information below is from the BC Government website, and should clear up any of the questions people had about its impact on their purchase.

‘Currently, new homes in B.C. are subject to the GST, and also carry an estimated two per cent embedded tax as a result of the PST paid on most construction materials.

Under the proposed Harmonized Sales Tax, new homes will be subject to the HST but the embedded PST will be eliminated because builders will be able to recover the tax paid on materials through input tax credits.

Used homes will not be subject to the HST.

An essential part of the BC HST will be a tax rebate for new homes.

A rebate of up to $26,250 will ensure that purchasers of of new homes up to $525,000 do not pay more tax due to harmonization than is currently embedded in the price of a new home.
New homes above $525,000 will be eligible for a $26,250 rebate.
This enhanced rebate represents a 30 per cent in the threshold and maximum rebate available.
New home sales will be subject to the HST
Sales of used homes will not be subject to HST
The Province is also proposing an enhanced rebate for new rental housing, similar to the enhanced rebate for new homes, to support the construction or substantial renovation of affordable rental housing in B.C.

The new rental housing rebate would ensure that, on average, new rental housing up to $525,000 would not be subject to any more tax due to harmonization than is currently embedded as PST in the price of new rental housing.
We will also provide a provincially-administered point-of sale rebate for residential energy, ensuring the HST will not increase consumers’ costs for oil, electricity, natural gas or propane used to heat or power homes.’

Will the bank be paying me?

Not too likely, but now is the time to pay yourself !

All those people out there with Prime minus variables, you know who you are. Your interest rates are sitting anywhere from 1.5% to 2.1%. Much lower and the bank will have to pay you! All kidding aside, you should be paying yourself by keeping your mortgage payments high, paying off more principle currently. It’s prime time to shave years off of your amortization! Remember, your pre-payment money is dollar for dollar. No interest!

Why the long face Mr. Smith?

On Jan. 8th, 2009 the Supreme Court of Canada handed down a decision making a form of the “smith manoeuvre” a tax avoidance move. While deemed not technically illegal, the court said it was an obvious attempt to avoid taxes. The government used a tax avoidance regulation (GAAR – General anti avoidance rule) to deem the manoeuvre an abuse of tax rules. The premise of the smith manoeuvre is to cash in your unregistered investments to pay the balance of your mortgage. You would then refinance your principle residence to buy back non registered investments. Previously, under CRA guidelines this makes the interest you pay on your principle residence a tax deduction.

CMHC premium tax deductible?

Is the CMHC premium a tax deduction on investment properties?

http://www.cra-arc.gc.ca/E/pub/tg/t4036/t4036-07e.pdf

You can deduct certain fees you have when you get a mortgage or loan to buy or improve your rental property.

If the loans relate to the construction or renovation period, first read about soft costs on page 9.

Loan fees include:
¡ mortgage applications, appraisals, processing, and insurance fees
¡ mortgage guarantee fees
¡ mortgage brokerage and finders fees
¡ legal fees related to mortgage financing

You deduct these fees over a period of five years.

Deduct 20% in the current tax year and 20% in each of the following four years.

However, if you repay the mortgage or loan before the end of the five-year period, you can deduct the remaining financing fees at that time.

The number of years for which you can deduct these fees is not related to the term of your mortgage.

If you have standby charges, guarantee fees, service fees, or any other similar fees, you may be able to deduct them in full for the year you incur them.

To do so, they have torelate only to that tax year.

You can choose to treat finance fees you paid and the interest on money you borrowed to acquire depreciable property as capital expenses."