Mortgage holders warned to weigh options

Ah, spring — when a young couple’s fancy turns to thoughts of real estate. Springtime has long been the most active season for real estate transactions, but the past several years have come with the bonus of historically low interest rates.

While central bank rates have been steadily creeping higher since bottoming out at 2% in 2002, a recent poll found many Canadians have not felt a significant impact on their standard of living.

According to a survey conducted for the Canadian Institute of Mortgage Brokers and Lenders, 42% of mortgage holders were content with their mortgage rates. The average mortgage rate currently held by Canadians is 4.9%, but when asked what they expected for the near future, 66% believe rates will increase.

“Our latest survey reveals that Canadians find their current mortgage rates manageable, despite increases over the past eight months,” said Ron Swift, President of CIMBL. “Although mortgage holders anticipate further rises, the study suggests that a majority will be able to tolerate an increase of up to 1%. That’s great news for the marketplace.”

CIMBL’s research suggests that if interest rates remain at current levels, 62% of Canadians would face increased interest rates at their next renewal. CIMBL says that for those renewing during the next one to six years, average costs will rise and peak in about four years.

On average, an increase of 50 basis points from current rates would result in a monthly increase of $50 in interest ($72 up from $22). Only 21% of respondents said they would see a significant impact on their standard of living for a monthly mortgage rate increase of $100.

Mortgage rates can be tricky to predict, as they are less directly related to the Bank of Canada rate, and more reflective of longer term bond yields. This makes perfect sense, as a mortgage is a long-term debt obligation, usually backed by an asset valued in excess of the obligation. Instead of being issued by a corporation, it is “issued” by an individual.

So should mortgage holder with a variable rate rush to lock in now? It may come as no surprise that one of the country’s leading lenders does not recommend it. The key, according to TD Canada Trust, is to avoid rushing into a long term decision based on short term information.

“It’s important to remember that whether you choose a fixed or a variable rate mortgage, your decision should be based on the facts around your personal circumstances and not attempts to predict the market, fuelled by the latest news about the prime rate,” says Rick Mathes, vice president of real estate secured lending at TD Canada Trust.

“When the prime rate is significantly lower than the five year fixed mortgage rate, as it was in early 2005, we saw over 40% of customers choosing a variable rate,” he says. “With the prime rate and five year fixed rate closer together, as they are now, that number drops to about 20%.”

Because they present greater risk to the borrower, variable rate mortgages carry lower interest rates than fixed mortgages. Most banks offer a convertible mortgage which allows the homeowner to take advantage of the lower variable rate, but allow them to lock in at a fixed rate if they suspect interest rates will rise.

Historically, home-owners have proven to be better off with variable rate mortgage, rather than fixed rate, because interest rates rarely remain elevated the duration of a mortgage. Much like equity markets, trying to time interest rates can be fraught with danger.

Mathes offers the following example:

In December, 2000, when the prime rate was 7.5% and the five year fixed rate was 7.95%, variable rate mortgages were unpopular, as people felt it was worth the small premium for the certainty of locking in their rate. Over the next five years, the prime rate averaged 4.7%. A customer with a $200,000 variable mortgage could have saved more than $33,000 relative to the five year rate.

Filed by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com