Good question. Today’s mortgage rates are really strange. We are actually getting a 2-year rate that is lower than both 1-year and variable.

Normally, we just take whatever rate is the lowest, regardless of the term. In most markets, you pay more for longer terms, but the amount you pay is usually expensive given the odds that interest rates will rise enough to save you money.

The best rates we are seeing today are:

Variable: prime -.2% (2.8%)
1-year: 2.69%
2-year: 2.49%
4-year: 2.99%

We are going with the 2-year in most cases.

The 4-year fixed is intriguing, but the 2-year will save you .5% for 2 years. You will be ahead unless the average of years 3 and 4 are more than 3.49%.

Like normal, it looks expensive to pay the extra .5% with the 4-year, plus you lose your negotiating power for 4 years, instead of 2.

It is difficult to know where interest rates are going now. It looks like they will stay low for a couple of years, and they may stay this low longer. Most likely, the economy will eventually come back and interest rates will normalize at perhaps 1% higher than today’s rates. That could happen soon or it could take 4-6 years.

There is also a possibility that when rates rise, they go too high first before settling down, as well as other possibilities. It is hard to predict rates long term and probably unproductive.

Generally, you should just go with the lowest rate, which today (for the first time in memory) is the 2-year fixed.

Ed

Could you comment on present day scenario (as of Jan 2012) where 5-yr fixed is available for 2.99 while variable is 2.8% and 1-yr fixed being 2.75

I’m more inclined to take 1-yr fixed but 5 yr looks attractive too (gullible smiley here).

What would you advice to someone who can handle variable for next foreseeable future?

One thing we have done is paid $80,000 of the mortgage principals. I’m sure that helped save some interest.

For those that locked in to a 5-year fixed at 3.59% 6 months ago, it is looking like it will end up costing you more. Current projections are that interest rates will stay at this level for a minimum of 1 year and probably 2.

That means that by locking in, you will have paid about 1% more than a 1-year fixed and about 1.5% more than a variable mortgage for all of the first 2 1/2 years of your term.

Is it too early to chalk up another loss for 5-year fixed mortgages?

By my calculations, since 1950, the score now is:

Five 1-year fixed 58
One 5-year fixed 0

Avoid the 5-Year Fixed Mortgage Trap.

Ed

I agree that it the savings from going short are less obvious when rates are expected to rise, but we believe that going short is virtually always the best thing to do.

The reasons we would stay short are:

1. The 5-year rate is hardly lower than an average mortgage rate in an average market. So capitalize on low rates for a year or 2.
2. Most likely, the average of the next five years’ 1-year mortgages will be lower than today’s 5-year rate (because it is based on the bond market).
3. 5-year fixed is the risky mortgage, not the safe one. Fear of a huge rate rise is vastly over-blown, but we have seen so many people pay the penalty to get out of their 5-year fixed.
4. The flexibility to refinance whenever you want that you have by staying short can be quite variable. We would want a significant clear savings before we would ever consider locking in anything.

Today we still have very low interest rates. This is a great time to capitalize on them!

Today’s 5-year rate at about 3.59% is not really much of a low rate. We have been recommending either variable or 1-year and rates have been between 4-4.5% most of the last decade.

So, 3.59% is only about .5% lower than an average rate in an average market.

Why not take this opportunity and have a really low mortgage rate? Rates will likely normalize over the next year or 2, but meanwhile, you have saved money for a couple of years.

Will you save money over the 5 years? You can do some simple math and estimate how much rates would have to rise to be even. If you take 3.59% * 5 years = 17.95%. If you get 2.45% for the first year, then take 17.95%-2.45%= 15.5%, to be even the average of years 2-5 would have to rise to 15.5% / 4 = 3.88%.

So, rates would have to rise by a bit more than 1.4% and stay there for years 2-5 to be even. Will they? That is hard to say, but most likely not.

Mortgage rates are based on bond market rates, which are based on the expectations of millions of investors. Bond market investors will always want a premium to take a longer term mortgage. Therefore, 5-year rates will ALWAYS be higher than the expectations of all investors for the average 1-year mortgage during those times.

Bond markets are far larger than stock markets and bond investors are generally better at forecasting than stock market investors. This is why short term rates have so consistently beaten longer term rates. The one study I saw from a mortgage broker showed that five 1-year fixed mortgages saved money over a 5-year fixed 100% of the time since 1950!

Many people feel “safer” in a 5-year fixed because of a fear of very high rates, like we had in the early 1980s. Things are completely different now. The main reason for the high rates in the 1980s is pushing rates down today.

The main reason for the high rates in the 1980s was demographics – millions of Baby Boomers entering the housing market every year and creating huge demand for mortgages. At the same time, there was a very small population of older Canadians that usually buy GICs, so the banks had little money to lend and tons of demand. Rates had to rise to even things out.

Baby Boomers are still the main driving force in the economy, but they are in their 50s today, so they are more likely to exit the housing market than enter it in the next decade or 2.

So, we think a large rate rise like that is very unlikely.

We see 5-year fixed mortgages as risky – not “safe”. The big risk in mortgages is that something will change in your life and you may want to refinance or (heaven forbid) have trouble making your mortgage payment.

With a 5-year fixed, there is a risk of having to pay a large penalty, which is part of why people with long term mortgages are far more likely to lose their home in a foreclosure.

The biggest factor, though, is that there is a big benefit in keeping flexibility being able to refinance. You may incur some debts that you could refinance into your mortgage, want to buy a car, move, etc. With a 1-year mortgage, you can refinance for free every year.

We would want a clear significant savings before we would recommend locking in a mortgage and giving up the flexibility to refinance.

Ed

I have been advised clients for 15 years, go one year at a time or variable. See my comments on mortgagetrends.com back in 2007.
http://www.canadianmortgagetrends.com/canadian_mortgage_trends/2007/07/could-100-oil-s.html

If you want to pay more and sleep at night go five years fixed. If you want to save… avoid the mortgage broker…bank talk. Remember brokers don’t get paid as much unless you sign for five years vs. one year or less (like open mortgage)

Brian

In general, the same concepts for saving money apply to both residential and investment mortgages. Commercial mortgages are a completely different animal and usually much more expensive, but residential investment mortgages are similar to personal mortgages.

We often hear people being less concerned about the interest cost of a rental mortgage because it is tax deductible, but saving money is saving money. In addition, it is generally smart to pay off a rental mortgage as slowly as possible and focus on paying off the non-deductible mortgage on your home. Rental income is also highly taxed once the mortgage is paid down a lot.

So, having lower interest rates by sticking with variable and 1-year mortgages might be more important with rental properties, since you may maintain that mortgage much longer.

Ed

I have not realize the similarity with Givens. I have a couple of his books, but really only skimmed them years ago. I’ll have to look at them again. You make him sound smart. :)

Ed

Thanks for the comments. You’ve made some good decisions (and learned from others).

Ed

And herein lies the problem, Ed. As I’ve noted above, your posts consistently make sweeping generalizations under the assumption that everyone is like your clients.

Alas, as much as we would like it to be so, the reality is that relatively few people are actually like your clients. Most people do not have the disposable income or risk tolerance to use leveraged investing like the Smith Maneuver. Many people cannot take the risk of payments increasing. We can smugly say “well, then they shouldn’t be buying a house”, but that isn’t going to change the reality that they are buying houses. And if they are so intent on buying a house despite their limited resources, blanket advice geared towards people with significant resources is not likely to serve them well.

Nobody has disagreed with you that VRM is likely to save money. But, you need to recognize that VRM is not a good fit for many of the people who do not resemble your clients. Like Tster, I find it extremely disconcerting that you do not seem to understand the concepts of “trigger points” for VRM, that you literally say “who cares” to the potential for clients to spend 5-years making payments only to owe more on their mortgage than when they started, and that you do not acknowledge that there is considerable risk to having negative equity in your single largest asset class.

Personally, I’m an advocate of what you are saying with regards to mortgages, as I am in a discounted VRM and plan to renew that way next year, unless the 1 yr fixed is a better deal.

I’m interested to hear your thoughts on Givens’ approach…even for an old book, some of his strategies still made sense.

Just to be clear – you are agreeing with me that a short term or open variable mortgage is more flexible – for those that qualify for a mortgage – right?

Then you must agree that someone with a mortgage due is in a better negotiating position than someone trapped in the middle of a term – right?

Two things that we think people should never do is “port” a mortgage or “blend and extend”. Both these end up adding an additional amount at the posted rate. You can’t really negotiate that. Posted rates are for losers!

I understand you point about the mortgage needing to fit the person. But do you agree that the vast majority of people are better off avoiding the 5-Year Fixed Mortgage Trap, Tster?

It’s hard to put a number on it, but I would estimate about 90%.

In short, we think that 5-year fixed is the “Poor Man’s Mortgage”. It is for the desperate, poor and fearful that have not set up any emergency funds, don’t qualify for a credit line for emergency use, are “2 pay cheques from bankruptcy” and are willing to pay thousands more in order to avoid an unlikely chance of a larger increase. They are for pessimistic people.

Variable and 1-year mortgages are for financially stable people. They are for people that want to build wealth or save money, that are not on the verge of bankruptcy and that have some savings or available credit for emergencies. They are for optimistic people.

Some people are taking the 5-year fixed now because they think “this is the one time when it might save money”. That is possibly true, if you are willing to lock yourself up for 5 years without being compensated for it.

Remember, the 5-year fixed is the “Foreclosure Mortgage” largely because of a huge penalty that prevents people that can’t afford their mortgage from selling their home for enough to cover the mortgage & penalty. If they could sell and get out, nobody would let their home be foreclosed on. That is possibly the best example of why being trapped is risky.

Part of why we don’t recommend 5-year fixed is that our clients tend to be focused on saving for their future and building wealth. They are following a written plan to achieve their goals, so taking a “Poor Man’s Mortgage” would rarely make any sense for them.

Ed

I have never said that a 1 year term or VRM is not flexible… I did say the following: “How does a VRM add flexibility to a client that does not qualify.” This statement is absolutely correct. A variable rate mortgage to a client that does not qualify is no more flexible than a FRM with the exception that you can get out without penalty. In other conditions you would be a fool to not believe that an open or short term mortgage is more flexible. My point to Ed was that it doesn’t add negotiating power to you position. Your negotiating power is reflective of what you can bring to the table. Ed has made it very clear that 90% of people should be in VRM. So in every comment that has been made not once has he stated that the client should take a FRM of longer than one term. So her HAS said that VRM are for everyone. It was even asked to him if he would give the same advise to a 70 year old as her would to a 25 year old. A question he never answered. As well as what his suggestion would be for investment and telling client to all be in equities instead of bonds since in the long run the will make more money… Another question he never answered.

You are correct in your 120 day early renewal… But you must renew to a fixed rate term with the financial insitution that holds you mortgage. I know you CANNOT early renew to a VRM open… but need to check on a VRM – closed. Once again I am not sure how much negotiating power you have when the bank knows that the mortgage must be renewed with them. And with the majority of client not having any idea of when the mortgage renews and in some cases signing renewal documents without even talking with their FI… that leads me to believe that the vast majoirty would not go out and apply with other FI’s in order to hold their rate until their mortgage could actually be moved.

Don’t get me wrong Ron. I suggest VRM to many clients. But it has to fit their lifestyle taking many things into accout including thoughts of building (not moving since mortgages can be ported), future education cost, debt levels, equity levels, job stability. I believe VRM are the best way to go…. but thats for me personally. I would not make statements that suggest that all clients should be Variable and not have the stability of a fixed rate in a rising interest rate envirment.

1/ Save money on your mortgage – I agree with this point. I am not sure that offering this advise to all client in all financial circumstance is the best thing to do. It is your blanket approach and you have made that clear. I am surprised however that you would offer this to the majority of your clients yet you cannot explain to them the biggest risk associated with a variable mortgage. Will payments increase as prime increase? Will payments increase once the trigger rate is achieved? How does increasing prime affect my amortization? These all seem to me as being basic questions on a VRM. You cannot focus soley on the fact that over history a VRM safes clients money without also disclosing to them that in order to get to that end scenerio there will be some heavy fluctuations in payments. Prime over the last 25 years has ranged between todays lows and 11.50%.

2/ Avoid risk of losing home – Clients who get in to trouble with high interest credits, loans that they wish to pay, education cost for kids or investing…. whatever the expense is. Fixed rate mortgage can be added onto WITHOUT PENALTY. Clients can blend existing terms with a new term on the new portion of funds added to mortgage. You cannot add-on to a VRM without closing and reopening the mortgage. This mean that “deep discount” you may have had on the mortgage you may not be able to get… especially if economic factor play into you cash crunch… It those times spread are usually low as we have seen in the last 18 months and dicounts on VRM are non-existent. And you final point about someone who loses their job, which is the worst case scenerio. Clients in either case would have to requalify for for EITHER a VRM or a FRM. How does a VRM add flexibility to a client that does not qualify.

As I have said in the past…. and I work for one of the banks you use… A client is in no better position to negotiate on a 1 year deal or variable which in most cases in a non-negotiable product. Why…?? the risk to the bank is greater as the mortage could walk out the door tomorrow ( in a case of a variable open or next year (in the case of a one year term.) You like hockey analogies. What are the chances that Kovalchuk will shop himself around for a 1 year contract? Very low, and the reason why is he risks losing the security of a long term contract that gaurantees him income in the event of an injury. Now remember Kovalchuk is the best UFA out their… he has lots of negotiating power as do clients that have equity, RSP, Investment, job stability. Most banks will not give more discount without the client agreeing to bring more business. You have talked about it before. It is not tied selling it is relationship pricing!! What I am getting at is that hockey players like clients are in positions of strengh in negotiation based on what they bring to the table not by the fact that they just play hockey or hold a mortgage…

Maybe you are right. I’m not misrepresenting anything – just telling you what our bank contacts are telling us.

We don’t just look at web sites. We talk to the experts. Since we have a mortgage specialist we work with all the time at various banks, why would I try to interpret what it says on their web site?

Our TD contact told me that they always send the letter giving you the option of increasing your payments any time prime rises. She has not yet confirmed your interpretation of the quote you found on their site, but your interpretation sounds right.

Our BMO contact confirmed that they increase the payment “if the loan balance exceeds 105% of the authorized loan amount.”

The mortgage document states:

“If the interest rate increases to an estimated _____% per annum, the Borrower’s first scheduled payment will not cover the interest that has accrued and become payable to the date of the Borrower’s first scheduled payment… As the Borrower’s payments are not adjusted automatically to reflect changes in the interest rate, negative amortization may occur.”

The reference to the first payment is because each payment reduces the principal, so it would take a larger rate increase before the 105% of the approved amount is reached.

We are trying to figure out exactly how high rates would have to go before the bank would increase the payment on a variable mortgage. We can get a variable today at 1.75% (prime -.5%). For a mortgage of $100,000 with a 25-year amortization, the payment would be $412/month. For rates to rise so that interest is $412/month, the rate would have to rise to 4.95%.

That would be a rate increase of 3.2%. If you are right, TD would increase your payment if rates rose MORE THAN 3.2%.

At BMO, rates would have to rise more than 3.2% plus increase the mortgage principal by 5%. That would mean, for example, an additional 5% for 1 year or 2.5% for 2 years. So, rates would have to rise by 8.2% and stay there for 1 year or 5.7% and stay there for 2 years, etc.

I guess that is why our contacts did not know the answer and said they have never seen a case where the payment was increased.

I can also say that in 15 years of referring people for a mortgage, I can’t think of a single case when a mortgage payment on a variable was increased.

We don’t deal with nearly all mortgage companies, so if having a payment increase is the major issue for you, then you should ask the mortgage person exactly how high rates would have to go before they would require a higher payment. See if your mortgage rep knows how high rates would have to go! :)

Ed