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decoding the mortgage market

Pssst. Have you heard that five-year fixed mortgage rates are below 3 per cent?

Apparently some people don't know that, or at least they didn't until BMO cut its advertised five-year rate on March 4th to 2.99 per cent. In doing so, BMO supposedly awakened those sleeping borrowers to the fact that rates are low, and at the same time drew criticism from Finance Minister Jim Flaherty.

Mr. Flaherty has been trying to pour cold water on a hot housing market with a series of mortgage restrictions. So BMO's rate discounting, which critics say spurs housing demand, has not been viewed favourably by the Department of Finance (DoF).

But the DoF apparently missed this news bulletin: Nearly every major lender in the country is offering 2.99 per cent on five-year fixed mortgages.

Some lenders call 2.99 per cent an "exception" and give you the "Let me speak with my manager" song and dance when you ask for it. But for well-qualified applicants, exceptions to 2.99 per cent or less are now the rule.

For weeks now, every major bank has been selling five-year mortgages under 3 per cent. They just haven't been doing it with public fanfare. RBC is even piloting a Rate Match program that's destined to attract customers looking for 2.99 per cent or less.

So given all this, what is actually accomplished by encouraging banks to keep mortgage rates artificially inflated?

Four things:

1) Rate obscurity
Discouraging banks from publicly advertising 2.99 per cent or less keeps a small fraction of borrowers in the dark about the real rates banks can offer. Believe it or not, some people still mistakenly believe that the regular rates banks advertise on their websites are the best they can get.

2) An edge for bank competitors
Less aggressive bank promotions have been a boon to some credit unions and brokers. Many of these bank competitors don't hesitate to offer market-driven rates like 2.79 per cent to 2.99 per cent. In fact, since Mr. Flaherty first encouraged banks to keep five-year rates above 3 per cent last spring, competing with banks has become noticeably easier, especially for many brokers.

3) Higher interest costs
Less rate competition means borrowers pay more. And the vast majority of those are responsible Canadians who don't over-extend themselves. Take a $200,000 mortgage for example. Paying a rate that's two-tenths of a per cent higher (e.g., 3.09 per cent instead of 2.89 per cent) costs almost $1,900 in extra interest over 60 months.

4) Higher profit per deal
Banks get their mortgage money from depositors and investors. Banks love it when they can maximize the spread between mortgage rates and the rates they must pay depositors and investors. The Finance Department's crusade against 2.99 per cent five-year fixed rates puts a floor under advertised bank rates, thus helping banks earn more by selling higher rates to unsuspecting borrowers.

The problem is, some banks may actually want to compete. But if they can't advertise market rates, that makes it harder to maintain overall unit volumes in a slowing housing market.

I've already noted that this most recent rate war is not new. I counted at least 30 notable lenders selling five-year mortgages at 2.99 per cent or less – and that was before BMO launched its promotion.

What's more, every big bank in the country was, and is, determinedly matching low rates for well-qualified customers. We're talking five-year fixed rates as low as 2.89 per cent or less. Internet rate comparison sites will continue to fuel these rate battles, with or without government rate intervention.

Unfortunately for the major banks, Ottawa has decided to single them out. They're now discouraged from openly and aggressively competing for your mortgage. BMO has been the only bank with the guts to break through Mr. Flaherty's artificial rate floor and transparently advertise rates that its competitors have been selling for months.

Critics will say that the last thing our housing market needs is more overt rate competition. They contend it will fuel "unnecessary" price appreciation. But the truth is, borrowers don't buy a home because they can save a tenth of a per cent on their interest rate.

Moreover, a rate savings like that would only enable borrowers to pay up to 1 per cent more for their property. That's hardly enough to create additional bubble-risk, especially since only a small minority of borrowers assume the maximum mortgage they can afford.

It's important to remember something else. Just because a lender offers low rates, that doesn't mean everyone is approved for those rates. People still need to qualify and lenders are still as scared as ever to incur excess defaults and face the wrath of regulators and investors.

Instead of quasi rate regulation, perhaps the government should impose higher insurance premiums or lower debt limits on less-qualified applicants who rely on government-backed mortgage insurance. That would immediately curb borrowing from marginal borrowers and temper home buying somewhat, sparing strong borrowers from higher interest costs.

That aside, it's ludicrous to tell a profit-driven but prudent bank that it can't compete by selling rates below an arbitrary 3 per cent level. What will the DoF do if bond yields (which determine long-term mortgage rates) fall another half percentage point? Will Ottawa forbid the Big Six banks from dropping their rates while every other lender in Canada is a half point lower?

When BMO went to 2.99 per cent in January and March 2012, it picked up less than one-third of a per cent of market share. Its promotion didn't create a housing bubble then, and it sure as heck won't create one in this slowing market.

Robert McLister is the editor of and a mortgage planner at VERICO intelliMortgage, a mortgage brokerage. You can also follow him on twitter at @CdnMortgageNews.

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