September 20, 2004

Blurb: The Bank of Canada finally turned the corner this month, raising its key rate. More increases are likely to follow. This has many homeowners asking themselves if it is time to lock in their mortgages.

Is it time to lock in your mortgage?

By Peter Diekmeyer o

The decision about what type of a mortgage to take out has always been something of a gamble. If you take out a variable rate mortgage, you generally get a better interest rate, but you leave yourself open to increases. If you take out a fixed rate mortgage, you have the security of knowing what your monthly payment will be, but you pay a little more each month for that security.

While the decision about whether to opt for fixed or variable rate mortgages is difficult at the best of times, it becomes even more crucial when rates are hit a nexus, as they did this month.
During its September 8th announcement, the Bank of Canada raised its key rate to 2 1/4%, ending a 14-month easing cycle, at the same time signaling that more increases are on the way. The major banks responded by raising their prime rates to 4.0%, as well as the rates that they charge on their variable mortgages, which are tied to the prime rate.

So if the Bank of Canada has turned the corner and begun raising rates, now must surely be the time to lock in, while the going is still good? Surprisingly - according to one expert, -- the evidence is by no means clear.

Balance of probabilities favors variable rate mortgages

"The balance of probabilities still leads us to conclude that a variable rate mortgage is the way to go," said Andrew Moor, president of Invis, Canada's largest independent mortgage broker, which has just completed a study of Bank of Canada tightening cycles during the past two decades.

The interest rate spread between what Invis (and many other financial institutions) currently charge for variable and fixed rate mortgages is just under 2%. (On September 8th, before the BoC rate hike Invis was charging 5.05% for a five-year fixed rate mortgage, compared to 3.25% for a five-year variable rate mortgage).

Coincidentally, this spread is fairly close to the 2.13% average that the Bank of Canada has raised rates during the 11 tightening cycles of the past two decades and to the 2.05% average rise seen during the past ten years.

Variable mortgage customers, -- who now comprise about 45% of the Canadian total,-- are betting that during the life of their mortgage, if rates fluctuate, that they will not rise higher than the five year rate. If variable rates do rise above the fixed rate, variable mortgage holders may still come out ahead, if for example the increases come late in the five-year cycle, or are not high enough to wipe out initial savings.

Two scenarios

To help mortgage holders understand the relative attractiveness of variable and fixed rate mortgages, Invis researchers put together two scenarios, based on rates that were available on September 8th, 2004. Both scenarios assume a $175,000 mortgage with a 25-year amortization period.

Under the first scenario, the prime rate would rise 2.05% to 5.8%, in line with a typical eight-month Bank of Canada tightening scenario seen during the past ten years. In this case, at the end of five years, variable rate mortgage holders would owe $153,710.13 and fixed rate holders would owe $155,009.28.

In other words, variable rate mortgage holders would save $1,299.45, over the life of the mortgage.

Under the second scenario, Invis researchers simulated what would happen if the largest tightening cycle that occurred during the past 20 years were to recur. Between April 1988 and April 1990, the prime rate rose by 5.0%.

If this were to happen to fixed rate mortgage holders today, they would owe $155,009.28 at the end of their five-year period, while variable rate mortgage holders would owe $172,113.00. In other words fixed rate mortgage holders would come out $17,103.42 ahead.

The bottom line: it depends

According to Moor, the key thing to remember when choosing a mortgage option is to make sure that it suits both your personality and your financial position. Those with high ratio mortgages or who do not handle stress well, are probably better off locking in their mortgages. On the other hand those with a more solid financial footing who are confident about the future are probably better off taking their chances with a variable rate product.



Copies of the Invis report are available at:


Peter Diekmeyer is the Montreal Gazette's management columnist. He can be reached at:


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