Owning a home in Canada has become even more expensive _ unless you live in Alberta, according to the latest housing report by RBC Economics Research.

The report says home ownership costs in Canada rose for the third straight quarter across all housing segments in the first quarter of 2010.

A strong real estate market and jacked up housing prices are getting the blame for putting a strain on Canadians’ bank accounts.

“Although home ownership became more costly in the first quarter of 2010, affordability measures are still moderately above the long-term average and below peak levels,” said RBC senior economist Robert Hogue.
“We expect affordability to deteriorate throughout 2010 and 2011, but this should be limited as more balanced supply and demand conditions will take much of the steam out of the housing market,” he said.

The RBC Housing Affordability report projects that the cost of owning a home will continue to rise.

The main contributing factor is an expected rise in interest rates, as the Bank of Canada moves towards raising the current exceptionally low rates to more normal levels through the second half of this year and in 2011.

According to the report, housing affordability measures in Canada are unlikely to exceed the peak levels reached in early 2008.

With the exception of Alberta, home affordability measures deteriorated across all provinces with a significant decline in affordability in B.C., Saskatchewan and Manitoba.

Housing affordability declined more moderately in Quebec, Ontario and Atlantic Canada.

Alberta is the only province to show a drop in the costs of owning a home.

Taking on a mortgage is a big commitment. Every buyer who uses a mortgage has the choice of floating or going with a fixed rate. The cost of making a decision to float or go fixed varies with the rate differences.

In 2008, Moshe Milevsky, Associate Professor of Finance at the Schulich School of Business at York University, and Brandon Walker, a research associate at the Individual Finance and Insurance Decisions Centre in Toronto, published a study that measured the direct and opportunity costs of going with either choice. “Over the long run, homeowners really do pay extra for fixed rate mortgages,” they concluded.

The reason is intuitive. Lenders do not want to take the chance that when they have to refinance a loan that they will be stuck paying more than they are getting.

Mismatching what they lend with the cost of what they borrow can cut their profits and even lead to insolvency. So lenders attach what amounts to an interest rate insurance fee and bundle that into the price of money they lend on fixed terms.

Milevsky and Walker confirmed this explanation. “The study showed that a positive Maturity Value of Savings [the value of investing the difference between floating and fixed mortgages in 91-day T-bills] was positive the majority of the time, so the homeowner saved by using a variable-rate mortgage.”

The amount of money that the homeowner can save by taking a chance on floating rates varied in the Milevsky and Walker study, depending on the time periods in question. But the average amount was impressive: $20,630 as of 2008. Put another way, floating allowed borrowers to cut the time it would take to pay off the mortgages by a year or more, in some cases as much as five years on 15-year amortizations.

There are other strategies that the buyer can use to provide some rate insurance without taking on what Milevsky and Walker have demonstrated as the high cost of peace of mind, such as taking a variable rate mortgage but set payments higher than the minimum required. That could be at the 5 year closed rate, which would mean a faster pay-down and growing asset security while still keeping the low cost of the variable rate mortgage. Faster pay-down is itself cost insurance if interest rates do rise.

Plan selection, it turns out, is gender-related. According to a BMO survey, men, 44% of the time, are more likely than women to choose a fixed rate mortgage than women, who make that choice only 28% of the time. Women, it turns out, tend to make the better choice, for as BMO’s analysis shows, “fixed rates were advantageous during only two periods – through the late 1970s and in the late 1980s, in both cases ahead of a period rising interest rates, as is the case now.”

So where are interest rates headed? The yield curve, a line that links interest rates for periods of time from 1 day to 30 years, implies that rates will rise, but not very much.

There is no sense that we are returning to a period of double digit rates. Moreover, there are deflationary forces at work, notes Patricia Croft, chief economist of RBC Global Asset Management in Toronto. “The present crisis in European finance and the potential fizzling out of the present recovery in North American capital markets could presage falling inflation and even disinflation – the subsidence of rising prices and interest rates,” she explains.

The April inflation data shows that Canadian inflation accelerated more than expected in April, inching closer to the Bank of Canada’s 2-per-cent target in the last reading before policy makers’ June 1 interest-rate decision. Although the Bank of Canada is being very cautious in its interest rate management commitments, the reports re-fuelled speculation that Bank of Canada Governor Mark Carney will lift his benchmark interest rate next month from the current 0.25 per cent.

For those who are strapped for cash, personal circumstance may dictate the choice of a fixed rate. But for everyone else, the folly of trying to make interest rate predictions over a business cycle and to predict both the short term rates and the long term rates along the yield curve should be apparent. No promises, of course, but the odds of saving money are with borrowers who choose variable rate plans or those that emulate them.

Read more:
http://www.financialpost.com/personal-finance/mortgage-centre/story.html?id=2994048#ixzz0nBvkqtNx

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