The golden age of variable-rate mortgages is over.
They're still a defensible choice if you're buying a home or renewing your mortgage, but the variable-rate option isn't the no-brainer choice it was a few years ago. In fact, fixed-rate, five-year mortgages look like the better choice right now.
Blasphemy, you say? Fair enough, given that the benefits of variable-rate mortgages have been talked up a lot in this column over the years. Priced off the prime rate used by banks for their best customers, variable-rate mortgages allow you to ride interest rates ups and downs over the years. In doing so, history has shown that you would have almost certainly paid less than if you locked into a five-year mortgage (that's the term chosen by almost everyone who goes with a fixed rate).
Benjamin Tal, a senior economist at CIBC World Markets and consumer credit expert, believes you'll continue to save on interest costs if you go with a variable-rate mortgage today instead of a fixed-rate loan. But the amount of the savings will be negligible, so much so that the worry-free comfort of the fixed-rate mortgage becomes a good value.
“Locking in now would not be a mistake,” Mr. Tal said. “In fact, it could be a good thing.” It's not just home buyers and people renewing mortgages who face the question of whether to go with a variable rate or a fixed rate. Large numbers of people are now working their way through variable-rate mortgages they set up a few years ago, and they're wondering about whether to use an escape clause that lets them jump into a fixed-rate mortgage.
To understand the appeal of the fixed-rate option, you have to look at how rates vary for short through long terms.
Rates traditionally move higher and higher for longer terms, but today short rates are the loftiest. The net result for borrowers is near parity for short-term rates and longer-term rates.
Variable-rate mortgages soared in popularity earlier this decade because short-term rates were much cheaper than long-term rates, and they were falling. Choosing a five-year mortgage back then was almost like buying a useless insurance policy against interest rate shocks where the premiums were in the form of much higher interest costs. Today, you can get that insurance at a much lower cost.
The posted five-year mortgage rate at the big banks hit 7.14 per cent last week, the highest since the summer of 2001. That's far from the last word on five-year rates, however. A couple of major banks offered discounted five-year mortgages at 6.08 per cent yesterday, and some credit unions and alternative banks were as low as 5.3 to 5.5 per cent.
Now, compare these rates to a variable-rate mortgage, which is currently priced off a 6-per-cent prime rate at all lenders. Discounts on this type of mortgage range from 0.75 to 0.9 of a percentage point, so your true rate would be as low as 5.1 per cent. Advantage, variable-rate mortgage.
For now, that is. Economists at RBC Dominion Securities said they expect rate increases this year and next that would push up the prime to 7 per cent. At TD Economics, they see increases that would increase the prime to 6.5 per cent. Not everyone agrees rates will rise, but if they do, it could drive up the discounted cost of a variable-rate mortgage above 6 per cent.
The benefit of going with a variable-rate mortgage is that you're poised to benefit should rates decline after whatever increases lie ahead. The question is, what are the prospects for rates to decline any time soon?
Many economists would say they're minimal because of the need to keep inflation under control. Mr. Tal believes there's a case to be made for the rate that influences the prime to be half a percentage point higher than it is now for the next few years. After that, he said, it's possible that inflation could become a greater challenge than it is now and thus trigger more interest rate increases.
Then again, there could be a major terrorist attack, or the Chinese economy could stumble and send a shockwave around the world.
Global interest rates would fall and people with variable-rate mortgages would benefit. Today, inflation is a serious issue for the first time in years and interest rate increases are widely expected. Sounds like a good time to pay what could very well be a nominal extra amount for the protection of a five-year, fixed-rate mortgage.
rcarrick@globeandmail.com
