What are the pitfalls with low interest rates?

Concerns about the sustainability of the high-flying Canadian housing market are “legitimate,” especially in the largest cities, the head of one of the country’s biggest banks said Tuesday as a price war rages across the financial sector over mortgage rates.

Bank of Montreal chief executive officer Bill Downe told the bank’s annual meeting in Halifax that soaring household debt levels are highlighting the need for a soft landing in the residential real-estate market. As a way of tightening lending, Mr. Downe said he supports a move toward shorter amortizations on mortgages in Canada to reduce consumer exposure to debt.

“We took a long, hard look at the Canadian housing market and concluded there was a legitimate concern that house prices – particularly in the largest cities – had been rising at a rate that was simply unsustainable,” Mr. Downe said.

“With growing concerns over household debt, a soft landing in housing is in the best interests of our customers and the national economy.”

His comments come as the banking sector battles to win market share for home loans by offering historically low interest rates. BMO in particular has come under fire from rivals for undercutting the market, offering five-year fixed rates at historically low rates of 2.99 per cent, and 10-year fixed rates at 3.99 per cent, forcing other lenders to match with similar offers.

Toronto and Vancouver are often singled out as overheating housing markets. Toronto’s average home price in February jumped 10.6 per cent from a year earlier to $454,470, as bidding wars for properties in sought-after areas often go well above the asking price. Despite a pullback in sales in Vancouver, prices there remain double the national average at $806,094.

Mr. Downe said BMO’s decision to focus on offering 25-year amortizations, as opposed to 30-year terms, is to direct consumers into loans that have lower costs over the long term. But RBC argues that BMO’s mortgage campaign involves terms that are less flexible and could prove costlier for borrowers if they run into financial trouble or need to refinance.

RBC argues that BMO’s cut-rate mortgages, which have shaken up the market, lack flexibility measures such as the ability to skip payments if needed, without penalty. The bank argues many people end up using such payment holidays at some point during the term of the loan.

BMO counters that such features add costs to the loan in the long term, because interest keeps accumulating. Both banks have taken out national advertising campaigns trying to poke holes in each ‘other’s offers in recent weeks.

Mr. Downe suggested he believes regulations may soon lean toward shorter amortizations. A year ago, the federal government announced it would no longer backstop mortgages with 35-year amortizations, making the maximum 30 years, as a way to tighten the lending market amid fears over rising consumer debt.

U.S. 10-year Treasury bond rates have increased 60 basis points since September, Mr. Downe said, a sign of upward pressure on interest rates in the future.

Source: Rob Carrick, Globe and Mail

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