Title: Is it time to go with fixed rate mortgage?

Sub-title: Locking in mortgage rates provides significant advantages. However the move can carry heavy costs.


Figuring out where the Canadian economy is going is a tough job. These days even experts seem perplexed at how turbulence in financial markets, the ongoing U.S. slowdown and spiking commodity prices, will unfold. It should thus come as no surprise, that to ensure stability, many homeowners with variable rate mortgages are thinking seriously about locking them in.


The big question right now relates to the seriousness of global inflationary pressures. Rising commodity and food prices and slowing growth in global supply chains are boosting consumer price indexes around the globe. The worry is that if sustained, these pressures could force central banks to boost their policy interest rates, a development that would almost surely eventually spur rising mortgage rates here in Canada.


“Times are challenging,” admits Gary Siegle, regional manager at the Calgary office of Invis, a pan-Canadian mortgage brokerage that arranged close to $7 billion worth of loans last year. “If trained economists can’t agree on where interest rates are going, how could the average consumer do so?”


The largest cost of homeownership

The decision regarding whether to take a fixed or variable rate mortgage is no mere academic debate. For many families, interest paid on mortgages represents the largest single cost of home ownership. The borrowing option they choose can swing family expenses by tens of thousands of dollars over the lifetime of their mortgage.


For example, in mid-August of this year, Invis’s mortgage customers could borrow at a fixed, ten-year interest rate of 6.25 percent. However the short-term variable rate was just 4.15 percent.  At those levels, interest costs in the first year on a $200,000 mortgage would run to $12,500, compared to just $8,300 in the case of a variable rate mortgage. That’s a $4,200 difference in just one year, which is a lot of money.


Of course those that opt for variable mortgage rates do pay a price: they cannot be sure that the interest rate that they are paying will remain the same forever. For example, in the early 1980s, in order to fight a previous bout of inflation, the Bank of Canada tightened its policy rate drastically and mortgage and other key lending rates skyrocketed to more than 20 per cent. While there is little likelihood that that will occur this time around, the example provides a constant reminder of how quickly things can change.


Where rates are now and where they are going

Much of homebuyers’ decisions as to which option they will opt for depends on the spread between interest rates charged on fixed and variable rate mortgages and where these spreads are expected to go. For example the difference between Invis’s fixed ten year mortgage rate of 6.25 percent and its variable rate of 4.15 percent is 2.1 percent. That means that as long as short term interest rates don’t rise by more than 2.1 percent variable rate borrowers can stay ahead of the game. As we saw earlier much of that depends on where inflation is headed.


The Bank of Canada remains fairly optimistic on this front. According to its recently released Monetary Policy Report Update, the consumer price index is projected to rise temporarily above 4.0 percent, before coming back down again later next year.


Those levels, while high, are not yet a major concern, says Mathieu D’Anjou, a senior economist as Desjardins Group, due to continued softness in Canada’s job market. Domestic employment fell by 55,000 posts last month, and by 5,000 jobs in June, shifts that help keep domestic demand here low. “Many forecasters are now saying that the central bank is unlikely to change its interest rate policy significantly over the short term,” says D’Anjou. “However the longer term outlook remains less clear.”


So what should mortgage holders do? “It’s a tough decision. I can really sympathise with those who want to lock in their rates now, while they are relatively low,” says Invis’s Siegle “On the other hand, variable rate mortgages holders have done far better for a long time now.”


“However things change quickly,” admits Siegle. “As recently as a month or two ago, oil prices, which were a key inflation driver, were hitting peak levels. But they have come back down significantly since then.” The one thing that Siegle insists on is that home shoppers get their variable rates mortgages pre-approved before they begin their quest. That’s because although lenders cannot guarantee the rate itself, they can guarantee the number of basis points that it will be discounted relative to the prime rate.



Recent Bank of Canada interest rate moves:

July 15, 2008, No change

June 10, 2008, No change

April 22, 2008, -1/2%, 3.0%

March 4, 2008, -1/2%, 3.5%

January 22, 2008, -1/4%, 4.0%

December 4, 2007, -1/4%, 4.25

October 16, 2007, No change

September 5, 2007, No change

July 10, 2007, 1/4%, 4.5%


Upcoming rate announcements:

Wednesday, 3 September 2008
Tuesday, 21 October 2008
Tuesday, 9 December 2008

Tuesday, 20 January 2009
Tuesday, 3 March 2009
Tuesday, 21 April 2009
Thursday, 4 June 2009
Tuesday, 21 July 2009
Thursday, 10 September 2009
Tuesday, 20 October 2009
Tuesday, 8 December 2009




Peter Diekmeyer (peter@peterdiekmeyer.com) is Bankrate.ca’s economics columnist.




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