Is it time to lock in your mortgage?

I’ve heard a number of times that ‘historically’ a variable rate mortgage saves you money over a fixed rate locked in mortgage. This sounds good, but it’s never been clear to me if that ‘history’ only includes the last 25 years or so when rates went from extremely high levels (in the 20% range) to the extreme lows of this decade.

With the Bank of Canada joining other world banks now expressing concern over inflation the assumption is that mortgage rates will be going up. If you currently have a variable rate mortgage is now a good time to lock in? Rob Carrick at the Globe and Mail says no -although locking in now would get you a pretty good deal, rates would have to rise by at least 1% to make a five year locked in mortgage a better choice.

If you prefer the security of a locked in rate your choices as a Canadian are limited. Unlike mortgages in the US where you can lock in a rate for the entire term of the loan, in Canada the longest lock-in I’ve seen is for 10 years. My own gut feeling is that with a small enough premium the full-term US style lock-in would be the best deal – five years might see you renewing at much higher rates. The problem is that nobody can predict how far or how fast rates will move, and if they start to move quickly the best time to be locked in will have already past.

Even if you’re not a homeowner these expected rate changes will affect on you, either with higher rates on consumer debt, changing bond and equity prices in your portfolio or just higher rates paid to you on high interest savings account. So what do you think – am I being to gloomy in my expectation of higher rates?

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Humble Studen of the
12 years ago

You can't have it both ways. If the economy weakens then inflation and commodity inflationary pressures will weaken…and so will property prices. With lower inflationary pressures the long bond rates will fall.

On the other hand, if the economy is strong then inflation will be a problem long bond rates will rise but the downward pressure will be off property prices.

Deliverator
Deliverator
12 years ago

The creditworthiness of the borrower matters little, because this is an incentive for the borrower to default.

…or to shoot his real estate agent in the head… six of one, half a dozen of the other, really…

http://tinyurl.com/3edxkg

RJB
RJB
12 years ago

"The cost of repairs to the tower was estimated at $29 million, and each of the 237 condo owners had to fork over at least $118,000, with the cost depending on the size of their apartments, Fox said."

Nice!

patriotz
patriotz
12 years ago

Which is why I say it’s a mistake to talk about “the subprime mortgage crisis” in the US.

To paraphrase Shakespeare, the problem lies not with the borrowers, but with the collateral.

The root cause of the mortgage crisis in the US is that loans were made far in excess of the fundamental value of the collateral. Now that the market price of the houses is adjusting back to fundamental value, as was inevitable, the mortgages are defaulting. The creditworthiness of the borrower matters little, because this is an incentive for the borrower to default.

That's really all there is to it.

blueskies
blueskies
12 years ago

re: leaky condos

love the way Concord Pacific suggests that strata

was not "proactive" enough to prevent these problems…..

Bizznitch
Bizznitch
12 years ago

Good link here…re. leaky condos.

http://www.cbc.ca/canada/british-columbia/story/2

alexcanuck
alexcanuck
12 years ago

LaLaLand;

Strataman has said a lot about shoddy work and problems in newer buildings. Lots of special assessments coming in a few years, helping to drive this great boom into the great bust.

LaLaLand
LaLaLand
12 years ago

Sorry…news item is on their TV news at 6pm. Buildings are Concord Pacific, Yaletown. Problems with their earlier tower buildings built 14 years ago. Only caught a few details: one building cost $8 million to repair. Strata and Concord reached a deal, but the settlement reached included a strict confidentiality clause as to the details.

New chapter in the leaky condo crisis, not entirely unexpected, but this bad publicity will surely hasten the turn in the condo market…

LaLaLand
LaLaLand
12 years ago

Off Topic to mortgages: CBC Radio just said that they will have a news item about newer downtown condos leaking at the windows. Owners being asked to cough up $ and the builder trying to keep the problem hush-hush.

Aleks
Aleks
12 years ago

Alexcanuck, I saw that too and had a little chuckle. Apparently these "re-remmic"s are better (how many times do you have to remix it before it stops being poison?). They're not backed by subprime mortgages, they're Alt-A mortgages "issued to borrowers with higher credit scores who don't prove their incomes, seek higher debt ratios or buy investment properties." Oh, good, sounds as rock solid as a t-bill. Mish periodically looks at a pool of Alt-A mortgages originated in May 2007. As of March 25% were 60 days delinquent or more, and 13% were in foreclosure. And that's after one year! Which is why I say it's a mistake to talk about "the subprime mortgage crisis" in the US. Subprime fell first and may be the worst, but there are a ton of bad Alt-A loans and I'd bet a bunch… Read more »

alexcanuck
alexcanuck
12 years ago

Did anyone see this on Bloomberg this morning?
http://tinyurl.com/6ahsne
They are repackaging those rotten fish (the CDO’s of the subprime mortgages) and trying to sell them again! Called ABCP in our Canadian version. I was in a rush and only skimmed it, but it blew my mind that anyone would get fooled again by a new name. The whole credit crunch is nowhere near over. This is the deflation Alistair Cookie was talking about on previous thread. All those imaginary dollars going poof and turning back into thin air.

Rocker Guy
12 years ago

Look at me: Okay, so maybe it was 5%. 2006 was different: The real estate market looked great. Investors WERE stupid.

Anonymous
Anonymous
12 years ago

Let me add my few cents to patriotz's post #8.

3. The interest you are paying to a bank is a sure thing. The interest you might receive is conditional (except GIC that is usually lower) and could be negative.

From my perspective, the best would be a balance of repaying and saving at the same time.

Look at me.
Look at me.
12 years ago

Umm a commercial mortgage with a fixed rate of 4.5% for 10yrs none the less… Let me be the 1st to call BS. All commercial mortgages no matter if they are fully backed or not command a higer interest rate. There is no one (not even via private investors) stupid enough to lone money at that rate for that long. If you can prove me wrong there's $10K in it for you as it would save me and others I know $100's of K in interest.

Rocker Guy
12 years ago

patriotz: Good idea – use the difference to pay the balance off faster. That provides a guaranteed high rate of return. A friend of mine who owns a $4M rental building (hah, well, it used to be worth that!) is using a 10yr fixed rate mortgage. He negotiated a 4.5% rate through hard bargaining back in 2006. The reason for seeking a fixed rate over a long term was that it reduced the risk of the investment somewhat. He can deal with a bit of vacancy, but if the interest rate shoots up 40%, the whole thing wouldn't work anymore and he'd be forced to sell during bad times. If you own a house now and don't already have a VERY long fixed rate mortgage, the best course of action is, of course, to sell it as quickly as possible… Read more »

foo
foo
12 years ago

One reason to keep the excess cash in a savings account rather than paying down the mortgage is to have an emergency fund. If you ever need some cash for something, you will pay through the nose to either get a line of credit or re-finance the mortgage.

That being said, the most sensible thing to do is figure out what the mortgage payment would be at the fixed rate (or some other higher rate), and pay that amount into your mortgage instead of the actual variable rate payment required. That way you pay down the mortgage faster while the going is good, and you're insulated from rate increases, because you're already making the higher payment.

Aleks
Aleks
12 years ago

One other thing to note is that mortgage rates are not directly tied to the Bank of Canada rate or even the lender's own prime rate. They're set in the bond market, so even if the BoC keeps its rate artificially low, mortgage rates could rise if bonds start pricing in higher inflation, or even just if bond yields rise because of lower demand.

patriotz
patriotz
12 years ago

Instead of locking in, put away the difference between your variable rate and the fixed rate into a high interest savings account, or other secure investment.

That's dumb for two reasons:

1. The interest you are paying on the mortgage is higher then what you will get from your savings.

2. The interest on your savings is taxable, but the interest on the mortgage isn't deductible for a principal residence.

If we get the TFSA next year #2 goes away, but not #1.

Instead, just use the extra cash to pay down the mortgage.

patriotz
patriotz
12 years ago

Forgot to add "mortgage" means "death pledge". In other words you are selling your future income in return for cash now.

Rocker Guy
12 years ago

.. BTW, nobody knows the future of interest rates. Don't fool yourself by thinking you know better than the market.

Rocker Guy
12 years ago

Instead of locking in, put away the difference between your variable rate and the fixed rate into a high interest savings account, or other secure investment. When rates go up as they inevitably will from time to time, your savings account can pay the difference. This will always work out more cost effectively in the long run. Another option is to invest the difference in long term risky investments, and have a large line of credit to tap in the case that rates go up.

patriotz
patriotz
12 years ago

i.e., “purchase a mortgage”; by the way wouldn’t it be good for everyone–except the REIC–if this phrasing were to catch on?

Well no, you're not purchasing the mortgage, you're selling it. The bank is purchasing the mortgage, along with any secondary buyers.

A mortgage is a secured bond sold by the borrower to the lender, like any other bond.

Booya
Booya
12 years ago

Can anyone explain why it is that you can get a 30-year fixed mortgage in the US but not in Canada?

mohican
12 years ago

Lock in – for as long as possible. The future is uncertain and I would want as much certainty as possible. If we look at the period of 1971 to 1981 as an example of a worst case scenario for variable rate mortgage holders that would be bad but many people have compared our times to those times.

mrjauk
mrjauk
12 years ago

I'm no expert but here's my 2 pennies.

First, if you believe that interest rates will rise substantially over the next five years, and you're using this as a reason to purchase a home (i.e., "purchase a mortgage"; by the way wouldn't it be good for everyone–except the REIC–if this phrasing were to catch on?), you're a fool.

You can always refinance, but if you buy a place that takes a $100,000 haircut (or more), then that is money that you have lost.

Second, if you already have a mortgage, rates would have to go up fairly substantially to make it worth your while. Will rates go up substantially? I don't think so, for a variety of reasons, but the most important of which is government paper will still be a relative safe-haven for the short-term.