Lenders grapple with credit crunch

Edited from an article by
LORI MCLEOD
Globe and Mail
October 8, 2008

Confusion is spreading through the mortgage market as lenders already grappling with soaring borrowing costs are now figuring out how to deal with a surprise rate cut by the Bank of Canada.
Banks were already been dealing with soaring borrowing costs before the central bank cut its key lending rate. This week Canadian Imperial Bank of Commerce decided to stop offering variable products to new mortgage applicants through its FirstLine Mortgages division until further notice.
CIBC's move comes on the heels of a decision earlier this week by Toronto-Dominion Bank to raise the rate on new variable mortgages to prime plus one percentage point.
Variable mortgage discounts have been eliminated at many other lenders, which are now offering them at prime. So far, only a handful have raised rates by as much as TD.
TD's move is a dramatic shift from the average discount of 0.5 of a percentage point lenders were offering off the prime rate just a month ago, and a reflection of current market conditions. While it may be a short-term phenomenon, people thinking about buying a home right now should lock in at current rates to give themselves a cushion against the current volatility.
Overnight, it seemed, TD made a knee-jerk reaction from prime to prime plus one. That is a big statement. Now FirstLine says we're not even going to price differently, we're just going to discontinue it because we can't figure it out. That in itself is saying things are in turmoil today.
Variable rate mortgages are based on the prime interest rate, the lending rate banks offer their best customers. As the cost of money the banks borrow to fund their loans to customers rises, mortgages are becoming less profitable for them.
The assumption in the past has been that they borrow from the Bank of Canada and make money on the spread in between, and that spread has been pretty juicy. The problem is, they're not borrowing from the Bank of Canada, they're using other instruments in the marketplace which may have saved them money in the past but are costing them money now. It's hard to retool a bank, it's like a freight train. Putting on the brakes and doing something different is not exactly what they're used to.
In the grip of the credit crunch, Canadian banks made the unusual move Wednesday of lowering their prime rates by a quarter of a percentage point, rather than matching the Bank of Canada's unexpected half-point drop on its key lending rate.
What it all means is that the variable rate at TD is now 5.5 per cent, and 4.5 per cent at a number of other lenders. Five-year fixed mortgage rates are posted at around 7.2 per cent, and with a discount many customers can get a rate in the 5.5 per cent range.
TD's higher variable rate will apply to new customers, while the bank will honour discounts existing customers have off the prime rate, said Joan Dal Bianco, vice-president of real estate secured lending at TD Canada Trust.
Recent increases in both fixed and variable rates were sparked by the bank's higher cost of funds, and TD has held off as long as possible before passing some of the costs to the consumer, Ms. Dal Bianco said.
As variable discounts are eliminated, the rates between floating and fixed mortgages are moving closer together. Variable mortgages will likely remain cheaper than fixed ones over the long run, but home buyers should make the decision about what mortgage is right for them based on their personal situation and risk tolerance.
People shopping for new mortgages should definitely not sign on for a long-term variable mortgage at prime plus one, however, since better deals are out there and conditions in the market may be short-term, he added. The good news is that rates remain relatively low. For example, the last time variable rates surpassed fixed rates was in the early 1990s, when mortgage rates were around 14.25 per cent.
Variable and fixed rates also moved close together in the mid-1990s, when they were in the 8 to 9 per cent range.