Is it time to lock in mortgage?
Garry Marr
Financial Post · Aug. 31, 2011
The gap between short-term and long-term rates has shrunk enough that it might be time for anyone renewing a mortgage to consider locking in.
Moves last week by the major banks to reduce the discount on variable-rate mortgages comes as the discounts for long-term mortgages have gotten as steep as they have ever been.
"What seems to be happening is they are focusing their attention on fixed rates. We are starting to see some aggressive competition on four-and five-year products," says Gary Siegle, a mortgage broker and Invis Inc. regional manager in Calgary.
How aggressive? Try as much as 190 basis points. A five-year, fixed-rate mortgage with a posted rate of 5.39% is now being offered for 3.49%.
For whatever reason, the four-year, fixed-rate mortgages are being priced even more aggressively.
Mr. Siegle says he can lock consumers into a four-year, fixed mortgage for as low as 3.09%.
The discounting comes as variable-rate products, linked to prime, have become more expensive. Short-term money has become more expensive in the bond market, forcing banks to reduce discounts.
The banks traditionally move their prime rate with the Bank of Canada rate. With no flexibility there and existing customers getting huge discounts based on old deals, banks are forced to raise rates for new loans as short-term money gets more expensive.
The trend began in April when FirstLine Mortgages, a subsidiary of Canadian Imperial Bank of Commerce known for its low rates, cut its discount on variable rates.
Others banks were slow to follow, hoping to make money on volume. But refinancings have dried up under tougher mortgage rules and sales have slowed, creating the need to tighten profit margins on variable-rate products.
Today, the discount on a variable-rate mortgage is about 55 basis points off the prime rate of 3% - in other words, 2.45%. Compare that to 3.09% on a four-year mortgage and the premium to lock in is not that much.
"This gap is about as narrow as it goes," says CIBC deputy chief economist Benjamin Tal. "It reflects a flat yield curve, which makes it difficult to make money in this business."
Mr. Tal says variable-rate mortgages tend to be more attractive when there are inflation expectations not yet expressed in short-term rates. This time, he says, the bond market is depressed, anticipating recession, and that has shrunk spreads dramatically.
The one thing keeping people in short-term money is the sense that there is no urgency to move because the U.S. Federal Reserve Board has pledged not to raise rates for two years, which also effectively ties the hands of the Bank of Canada.
"We know the five-year rate is attractive, but we also know short-term rates are not raising," Mr. Tal says.
What does that mean on a practical, dollars-and-cents basis?
Let's use the Canadian Real Estate Association's 2011 average sale price forecast of about $360,000 and assume a 20% down payment and a $288,000 mortgage.
At 2.45%, your monthly mortgage payment based on a 25-year amortization would be $1,282.98. At 3.09%, your monthly payment rises to $1,376.28.
But even at the gap, you would pay about an extra $7,000 in interest to lock in over four years.
Ultimately, the $7,000 amounts to an insurance policy. You get payment certainty for four years, but at a price.
If rates climb 200 basis points on your variable-rate mortgage, it could cost you $22,000 more in interest over four years. The reality is that rates wouldn't jump at once and, therefore, increases would likely be gradual.
Moshe Milevsky, the York University finance professor who wrote the oft-quoted study that variable-rate mortgages do better than fixedrate mortgages 88% of the time, said if you start thinking about it like insurance, it comes down to your risk tolerance.
"There are people who pay a lot for protection on their portfolio; there are people who pay a lot for life insurance," Prof. Mr. Milevsky says. "If the premiums are low enough, you might say, 'Sure, I'll pay.' But if you have a tight budget, every basis point counts, and it might not be worth it."
To me, he still has the ultimate answer for the tough decision whether or not to lock in.
"I still don't get why more Canadians don't split their mortgage," Prof. Milevsky says. In other words, locking in half of the mortgage and floating with prime on the other half.
"When is a bank going to come to the realization Canadians hate making this choice?"
He's right. Even with rates this low and the gap between short-term and long-term rates this narrow, it is still a tough call.
Photo By: Accretion
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