VMD brought this article to our attention from canadianmortgagetrends.com by Rob McLister: The Incredibly Shrinking Variable Discount
Just weeks ago you could find variable-rate mortgages at prime – 0.80% (P-.80%) or better. Consumers thought they were here to stay, but the tables turned…fast.
Economic troubles and lender profit motives have shrunken variable discounts beyond expectations. Banks are now commonly quoting prime rate, for example, with little discounting.
Once the last few holdout lenders with P-.50% disappear, discounted variables could move towards P-.25%…or worse. Some lenders even suggest that prime or prime plus could be the new normal.
While variables have cost less than 5-year fixed mortgages a majority of the time in the past, favourites don’t win every game.
More importantly, assumptions are key when it comes to rate studies. Two important factors have impacted the research quoted above:
- A multi-decade bias towards falling rates
- Use of posted rates (instead of discount rates)
“Interest rates have been trending downward for two decades,” BMO Capital Markets Senior Economist Benjamin Reitzes told us in a recent interview. By default, he says, that’s tilted the table more in favour of variables than it otherwise would be.
Looking ahead, rates are no longer able to drop over one percent. The most we can realistically hope for is an extended period of horizontal rate movement. (The BoC can still cut rates slightly, but the European and American crises and sub-2% core inflation won’t delay hikes forever.)
As a result, Reitzes says, “Going forward, borrowers won’t see the same advantage to variable rates as they have in the past 25 years”
The second factor that’s largely ignored when citing rate research is the actual mortgage rates used for backtesting. Each of the three studies above uses posted rates in their historical analysis…
According to [Moshe] Milevsky, “…The historical probability of doing better with the floating rate mortgage…hovered around 70% to 80%” when the borrower used deep discount rates (based on a 1965-2000 study period).
Using today’s discounts, that 70-80% drops to just 53%, based on our findings from 1970 to 2006. (Obviously today’s spreads would not have applied historically but, as Milevsky maintained in his research above, that is beside the point.)
In other words, the fixed/variable decision would have been a coinflip, based on today’s spreads.