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Last Tuesday, TD Canada Trust increased its mortgage prime rate (which is the rate that it uses to price its variable-rate mortgages) from 2.70% to 2.85%. In today’s post, I’ll provide a quick example to illustrate the impact of this change, and offer an insider’s point-of-view on why there was more to it than first meets the eye.
Let’s assume that a TD borrower has an existing $300,000 five-year variable-rate mortgage at prime minus 0.50%, and that this loan is amortized over twenty-five years.
Prior to last Tuesday, his rate would have been 2.20% (which we calculate by taking the TD’s previous mortgage prime rate of 2.70% minus his discount of 0.50%), and his monthly payment would have been set at $1,299. As of last Tuesday, his variable rate has now risen to 2.35%, but whereas most borrowers would expect the bank to increase his mortgage payment by the additional $22.10/month that would be needed to maintain his original amortization, TD’s standard practice is to hold his payment steady and extend his amortization period instead.
To understand the impact that this extension in amortization will have over time, let’s look at the borrower’s mortgage balance at renewal both before and after TD’s most recent rate hike.
Before the rate increase, the borrower’s balance at renewal would have been $252,363, assuming that his rate had held steady over his mortgage term. After the rate hike, because TD didn’t increase his monthly payment by the additional $22.10 and extended his amortization period instead (which is TD’s standard approach unless specifically instructed otherwise), his balance at renewal will increase to $253,763, which is $1,400 more than it would have been had TD not raised its rate.
To be clear, if you are a TD variable-rate borrower you can call the bank and have your payment increased to account for last week’s rate hike, but you have to initiate the call. Otherwise, expect to have a higher balance at renewal.
Most market watchers quickly concluded that this rate hike was tied to the Department of Finance’s latest mortgage rule changes, but I don’t see it that way. These changes reduce the availability of mortgage insurance going forward, and will thus raise a lender’s cost to fund some of its mortgages in the future. But TD’s mortgage prime-rate hike raises borrowing costs for all of its existing customers, even though their mortgages were set up prior to the latest rule changes.
From TD’s perspective, if the cost of funding future mortgages were to rise, the most appropriate response would be to reduce the discount that it normally offers on its variable-rate mortgage applications going forward (in the example above, this might mean reducing a borrower’s variable-rate discount from prime minus 0.50% to prime minus 0.35%). Instead, by raising its mortgage prime-rate on its entire book of existing variable-rate mortgages, TD is giving itself a much bigger profit bump, albeit less justifiably.
Interestingly, in at least some cases, TD has increased the discount on variable-rate mortgage approvals currently in its pipeline in order to offset this rate increase. So in cases where borrowers could choose to cancel their TD application and move to a competitor, TD is foregoing this rate increase, even though these new mortgages are the ones that are likely to cost TD more to fund.
While the latest mortgage rule changes gave some cover to TD, I suspect that its decision was a pre-emptive move in anticipation of more changes that are still on the horizon. To wit, our banking regulator has warned that it may require lenders to increase the amount of capital they allocate to their mortgage portfolios, and if that happens, it will raise their cost of funds. Against that backdrop, TD’s decision makes more sense, but to be clear, there have not yet been any official announcements about higher capital requirements and the topic is not specifically referenced in the most recent mortgage rule changes.
The lack of any official announcement from the banking regulator may explain why no other lender has yet followed TD’s lead. For whatever reason, when TD tries to lead the market, other lenders just don’t tend to follow. To cite another recent example, last year when the Bank of Canada (BoC) lowered its overnight rate by twenty-five basis points, TD quickly dropped its prime rate by ten basis points, hoping that other lenders would match, but that didn’t happen. Instead, RBC dropped its prime rate by fifteen basis points and the rest of the market followed. TD then lowered its prime rate to fall into line, but was left looking like the greedy lender who tried to grab an extra five basis points in spread. This time around, TD’s mortgage prime-rate increase has made headlines again, and other lenders have once again stood pat.
Isn’t the definition of insanity doing the same thing over and over and expecting a different result?
Five-year Government of Canada bond yields fell five basis points last week, closing at 0.67% on Friday. Five-year fixed-rate mortgages are available in the 2.24% to 2.39% range, and five-year fixed-rate pre-approvals are offered at around 2.59%.
Five-year variable-rate mortgages are available in the prime minus 0.40% to prime minus 0.50% range, which translates into rates of 2.20% to 2.30% using today’s prime rate of 2.70%.
The Bottom Line: TD raised its mortgage prime rate by fifteen basis points last week, and that means affected borrowers will now take longer to pay off their loans unless they take the initiative to have their monthly payments increased. While the mainstream media attributed this rate hike to the latest round of mortgage rule changes, there was nothing specific in those changes to justify a rate rise for TD’s entire book of existing variable-rate borrowers. Rather, I think this was a pre-emptive move in anticipation of higher capital allocation requirements,which have not yet materialized, and an attempt to lead the market higher. No other lender has responded thus far, so TD’s attempt to be a leader has thus far left it as a loner instead. Stay tuned.