Thursday, September 06, 2012

The Mortgage Renewal Gap

Something that used to be tracked on local blogs (by Van Housing Blogger) is the so-called "renewal gap" that asks the question, what interest rate differential (IRD) would someone see if they renewed their mortgage today? This is calculated by looking at the mortgage rate N years ago, where N is the length of the term, and subtracting it from the current mortgage rate.

There are both posted and "discounted" mortgage rates and Ben Rabidoux pointed out to me that this spread has been increasing recently due to some "mortgage wars" reported between vendors chasing yield (or whatever). To help weed through this, with Ben's help, I have found three data series of mortgage rates:

  • The "posted" mortgage rate tracked by the Bank of Canada on its website (V122521)
  • The "average" mortgage rate surveyed by CMHC from its lending partners (CANSIM Table 176-0043)
  • The mortgage rate tracked by Ratehub, which tracks discounted rates.
The first graph looks at the 5 year rates from these three data sources:

And the spreads between the data series:
The renewal gap of the average and posted rates, with the spread between the two, is as follows. I have assumed future rates maintain July 2012 values indefinitely into the future. (This could be slightly improved by using bond futures to provide best-estimate of rates going forward.) (The Ratehub and average have almost exactly the same renewal gap calculation)
Here is the posted renewal gaps for 1, 3, and 5 year terms:
  • The 1 and 3 year posted renewal gaps are now roughly zero. That means borrowers on these term lengths will not see much debt relief upon renewal going forward. This is a big change from 2011 when the 3 year posted had average IRDs under -2%.
  • The 5 year renewal gap is markedly negative, to the tune of close to -2.6%. Absent any significant interest rate moves or changes to discounting this will continue for another 16 months or so after which the renewal gap shrinks close to zero again. This means that the fraction of households whose mortgages are up for renewal in the next while are able to significantly reduce their financing costs, all else equal.
  • The "mortgage wars" where significant discounts are being offered compared to posted rates have been increasing over the past year.
  • It should be no surprise the Bank of Canada and the Government of Canada have acted by clawing back amortization lengths, twisting rates, limiting refinancings, and taking OSFI's machete to bank lending practices (to name a few), given the large and persistent negative IRD on 5 year term renewals.
The renewal gap on mortgages is still accommodative but 2012 has seen some tightening due to the 3 year gap hovering around zero again. The 5 year gap is still markedly negative and this will tend to be a tailwind for the economy as borrowers continue to refinance in favourable conditions. That, taken by itself, is a bullish indicator for housing over the next year or so. Whether households are increasing their debtloads upon renewal or keeping their original amortization schedules is another discussion.


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Allen D. Harper said...

This is really a great post. Thanks for sharing. IRD calculation is always a great task during mortgage renewal time. And it is not good to accept the first offer that bank presents.
I think it is very important for everyone to get advice on mortgage renewal process.

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