We are recommending the 1-year fixed at 2.4% now. The current 5-year fixed rates are not low compared to normal short term rates.

By using only variable or 1-year rates, we have been between 4-5% almost all of the last 15 years. The current 5-year fixed rates are not low compared to this.

Variable rates are reasonable in absolute interest rate (prime +.6% is only 2.85%), but we think that the varaible below prime will return at some point (hopefully soon), so we would be hesitant to lock in a variable above prime.

We are getting 2.4% on a 1-year fixed now, which is significantly below normal interst rates. So, just enjoy the low rates for a while.

Based on what the Bank of Canada is saying, we may well be able to get a similar rate a year from now. Hopefully, we will be able to get a variable below prime by the time the low 1-year rates end.

The 5-year fixed rates have never saved money in the last 60 years, so you have to assume that it will end up with them not saving money again. Interest rates were about this low and rising in the early 1960s, but the 1-year rates ended up saving money over the 5-year fixed every year then.

So, the odds heavily favour the 1-year fixed over the longer terms, just like always. Almost everyone we know that has had a 5-year fixed has found it worthwhile to pay the penalty to get out of it at some point during the term.

Shorter terms also give you the flexibility of renewing with a strong negotiating position every year. During the term of a mortgage, you have no negotiating power. So, a 5-year fixed means you have no negotiating power for 5 years. We find that scary!

Every time your mortgage comes due, you can negotiate extra goodies – mortgage rate discounts, free banking for a year, low rate unsecured credit lines, a free home appraisal, some Air Miles, etc. It is strange that many people lock into 5-year rates largely because they are uncomfortable with negotiating. When you know how to negotiate effectively with banks, you look forward to having your mortgage come due.

Ed

Where are you getting prime -.5% now?

Ed

Mortgage is now at 1.75%

Posts didnt mention final decision made

[...] the start of the process, my husband and I were undecided about whether to go with a fixed or variable rate mortgage. Our friends and some of the mortgage agents were of the opinion that mortgage rates were on the [...]

Great name! “Re-negotiating with the bank is as fun as going to the dentist in your underwear.”??? Are you saying this would be fun??? :)

Actually, we teach our clients to negotiate effectively with banks. It IS fun – and profitable!

Negotiating is only a pain if you don’t know what to ask for. We tell our clients what the best rate available is on an SM mortgage and then explain how to “negotiate” effectively. It’s not really negotiating if you know the bank’s bottom line and the best available SM mortgage elsewhere. Either their bank matches or beats the rate, or we move the mortgage. It’s that simple.

Quite a few of our clients have told us they now enjoy wathcing their bankers squirm.

Meanwhile, we can negotiate all kinds of goodies every time the mortgage comes due – best rates, an unsecured credit line at a great rate, free reappraisal of your home, free banking for a year, etc.

If they work through one of our contacts, then we do all the negotiating for our clients, so it is really just a matter of signing.

Finders fees are not all the compensation for mortgage brokers. There are often bonuses, volume bonuses and/or various allowances. Also, the firm’s share varies between firms and depending on the volume the broker does. Brokers I’ve talked with tell me they average closer to .9-1% and somewhat higher with longer terms. Has this changed?

Your comment about interest rates being very hard to predict, especially longer term, is well taken – and is what I was trying to say in my last post. My point, however, is that if you can’t predict long term rates and short term or variable always (or almost always save money), why would anyone ever take a long term fixed mortgage? Taking a 5-year fixed mortgage any time gives you nearly a 100% chance or wasting thousands of dollars in interest.

Since variable and 1-year mortgages beat 5-year mortgages 93-100% of the time (depending on the study), why would anyone ever bet against these odds unless they were very positive about where rates were going long term?

Banks obviously benefit hugely from 5-year fixed mortgages, both in the much higher interest in almost every market and by not having to pay staff or costs related to renewals.

I’ve always wondered why mortgage brokers don’t strongly recommend only 1-year or variable mortgages. Would that not give them a competitive advantage over banks. Since brokers are supposed to be specialists, why not give real advice to save their clients money?

Rates have been quite flat recently. Normally, 5-year fixed rates are much higher than variable or 1-year rates. Flat rates, like we have now, almost always lead to lower rates. This is clearly happening over the next year or so, with the only debate being how many prime rate reductions we will get.

You may be saving 20 basis point when you signed your mortgage, but this could easily widen to 1% or more over the next few years – perhaps this year.

Your last point about only those that could not handle a huge rate increase taking a long term fixed mortgage is interesting and is what we used to believe. However, we realized this means that those that can least afford it should pay thousands extra in wasted interest payments.

The issue is rarely handling a rate rise of 1% or less, but being able to handle a much larger increase – like what happened in the ’80’s. Many people consider the higher interet cost to be an “insurance” against rates like in the ’80’s. Those extremely high rates happened for a specific demographic reason and are therefore very unlikely to ever happen again.

We sometimes recommend that someone that can barely afford a mortgage take a variable or 1-year mortgage, but make the mortgage payments they would have made with a 5-year mortgage. Put the difference away, so you can draw on it if rates rise. After 5 years, there will almost definitely be a few thousand dollars put away. This extra cash is also an insurance policy, but is not expensive.

Our clients may not be representative of Canada’s population and there may be some cases where a longer term may make some sense, but we have not found a single client in the last 15 years where the best choice in a mortgage was anything other than a 1-year or variable mortgage.

I have to admit that I don’t understand why all mortgage brokers don’t think this way.

Ed

Re-negotiating with the bank is as fun as going to the dentist in your underwear.

Doing this every year with a one-year mortgage is aggravation X 5.

In addition, and no offense, your assertion that brokers make more on variables than fixed mortgages is an inaccurate blanket statement. FYI, finders fees for most mainstream lenders average 75 basis points in either case. (P.S. Your “broker propaganda” line is out of date as well.)

As for rates long term, many prominent economists like Benjamin Tal predict higher medium to long-term rates because of higher inflation. So saying that rates will be low for years is therefore highly debateable.

Given the uncertainty of the future, and the fact that variable and fixed rates are very close right now, I’d say the decision depends mostly on one’s ability to absorb possible increases in prime.

In my case, I’ll happily go with a variable and hope to save 10-20 basis points, because the worst case can’t hurt me. A first-time homebuyer with no savings might think differently however.

[...] other hand, is more steady, but with lower pay.  It's kinda like choosing between going variable or fixed on your [...]

1. They think their payment will rise if rates rise.
2. They hate negotiating with banks.
3. They are scared of a 1982 scenario with 20% rates.

We explain to them that:

1. Your payment does not change during the term with a variable mortgage if rates rise. We’ve been getting a 3-year variable that is open, so you can change the payment to anything you want at any time anyway.
2. Negotiating with banks is fun and profitable. Plus having their mortgage due (or open) is helpful to enhance the Smith Manoeuvre.
3. The same demographics that caused the 1982 high interest rates (Baby Boomer mortgage demand vs. their parents GIC supply) will now push rates down for decades. Very high rates are a very unlikely scenario.
4. 5-year fixed mortgages are almost definitely a massive waste of money. They will probably have to work a full extra year before paying off their mortgage – and with the Smith Manoeuvre, they will probably have to work a full extra year before they can afford the retirement they want.

The banks and mortgage brokers have been running propoganda to promote long term fixed rates for years, since they make far more on them. But once we stop operating from fear and start thinking about building wealth and moving forward with their financial goals, then it is clear that variable, open and short term mortgages are all advantages.

Ed

We do think differently! What you mean is that it would take one more increase – plus interest rates staying that high for a full 5 years – for the fixed rate to not lose money.

Our clients have been taking only 1-year and variable mortgages since the mid 90’s and we’ve been below 5% for 8 of the last 12 years. Demographics point to continued low rates for a very long time and we think we are at the top of the interest rate cycle now. We expect rates will be back down to normal within a year or 2.

Even if I thought the fixed rate would be anywhere close, I would have trouble being IMPRISONED in a 5 or 10-year mortgage. How could I sleep knowing I am STUCK and have given up all negotiation power with the bank for 5 or 10 years? Oh my god, it panics me just to think of it!

Every time your mortgage is due, you have great negotiation power with your bank, since the market is so competitive. We teach our clients to negotiate with banks and try to find the best deals for them.

During your term, you have no cards to play. What if we want to move or refinance? We usually want to have our home reappraised every couple of years and increase our leverage. If we wanted to make any change, the bank can charge legal fees or appraisal fees or whatever they want, and we would be TRAPPED. My entire financial life would be STUCK for years if we ever took a fixed rate.

Every time our mortgage comes due, we can negotiate goodies – free banking for a year, a discount on an unsecured credit line rate, higher credit line limits, etc. All our options are open to us and we will be in the driver’s seat in any negotiation with the bank.

We don’t have a mortgage, but our leverage is all at variable rates. I can “sleep at night” knowing I will almost definitely save thousands of dollars after tax over all those people that have fallen for the bank and mortgage broker propoganda by TRAPPING themselves in fixed mortgages and giving up all negotiation power for years.

Personally, if I expected rates would have a HUGE jump of more than 4%, I might consider IMPRISONING myself in a mortgage as long as 2 years. Anything longer and I could not sleep at night!

Ed

As recently as 4 weeks ago when anyone could’ve locked in a 5-year fixed at 5.25%. Usually the pre-approved mortgages are good for 120 days, so it’d only take 1 more hike for fixed-rate mortgages to leap ahead. The spike was sudden but small; it’s doesn’t have to be the 15% or 6% hike as in your examples.

I worry about generalizing any stistical results that aren’t circumstances-based. I agree that in most scenarios, it’s better to borrow variable, but we’re in an unusual period where short and long yields are similar. If you’re an investor, you want to go short. Conversely, if you’re a borrower, you want to go long (possibly 10 years).

Most economists are predicting 1 or 2 increases this year, which is nearly half over. Now it’s a question of magnitude of reward versus risk. Is that potential 0.35% or 0.15% savings worth losing sleep over?

All the periods where 5-year fixed beat prime had one thing in common – they were at the peak of a sudden, large interest rate rise. Through the 50’s and 60’s with low rates, it was never close.

There were only 2 longer periods of time where the fixed rate was lower for more than 2-3 months:

1. 1979-82 when prime shot up from 8% to 23%.
2. 1989-91 when prime rose from 9% to 15%.

Here is a link to the study. Look at page 28:

http://www.rbcroyalbank.com/RBC:Rlxiro71JsUAAZ6AbGM/products/mortgages/pdf/Mortgage_Financing_IFID_Reasearch.pdf

FT, while some economists are predicting a series of rate increases, the general concensus is only 1 or 2 increases.

In your case, to bet on the fixed would be to bet on 4 or more increases – plus that rates will stay that high for 5 years!

Ed

I’ve not looked at Milevsky’s study, but I wonder he revealed the magnitudes of the savings in addition to the frequencies (88%).

Were the probabilities randomly distributed? What were in common when Fixed beat Variable over the other 12%?

A prudent question to ask is, did Milevsky also crunch the stats in the context of historical low interest rates when VRM are likely to rise higher? What about flat yield curve?

If I recall correctly, one could’ve locked in a 10-year fixed at around 4.75% 3 years ago.

Stick with variable. 5-year fixed mortgages are 1 of the 4 main ways Canadians waste tons on money.

CC is right. Moshe Milevsky’s study showed that variable rates have saved money 88% since 1950 and that the average Canadian wastes $22,000 after tax in their life because they take 5-year fixed mortgages. But his study is based on prime! And this $22,000 wasted is for every $100,000 of mortgage!. Your rate of prime -.85% would have increased the odds of saving money with variable to virtually 100%.

What is more, with the discounted variable rate, your savings projected over your life would jump from $22,000 to nearly $40,000 for every $100,000 of mortgage!

One study by one of the very few mortgage brokers that recommends 1-year mortgages showed that 1-year mortgages have also saved money 100% of the time vs. 5-year fixed. I had always thought that the period of time in the early 80’s would have been the only exception to this, but the study showed that you would have saved money 2 years and lost money 3 years with an overall savings to 1-year.

This means that your odds of saving money with a 5-year fixed EVER are virtually zero compared to either a discounted variable or 1-year fixed.

The myths of 5-year fixed are promoted by banks and mortgage brokers that both make much more money on them.

The “sleep at night factor” is bunk as well. Your payment is not increased with a variable mortgage if rates rise – so you still will always know your payment. And “knowing what my rate will be”? How can odds of virtually 100% of losing money by going 5-year fixed help you sleep at night?

Unless I was expecting a massive interest rate of at least 4% within a year, I always suggest to my clients to only consider 1-year fixed or variable.

Since you are building, there is still some logic and nothing to lose by getting a rate guarantee – but guarantee the 1-year.

Ed

P.S. Since you are doing the Smith Manoeuvre, the 5-year fixed also means you cannot refinance your home and increase your HELOC and your SM for 5 years. A further waste of money…

“Growth in Canadian retail sales in April was lower than expected, undermining the widely-held view that a Bank of Canada interest rate hike in July is almost a certainty.”

Looks like now maybe you should go variable again. Two news post contradicting each other on the same day, who would have thunk it?

Just all the more evidence to lock in and stop trying to guess what’s going to happen. If your comfortable paying the current rates, just ’set it and forget it’.

There is so much hype and garbage out there you are never going to be able to tell what’s real and what’s going to happen until it’s already happened. By that time it’s far too late to matter.

I think I’ve posted more than enough on the subject now and I think my view is pretty clear.

“Most observers now expect the Bank of Canada to ignore protests from some provinces and begin raising its key overnight interest rate in two or even three quarter-point increments starting July 10.”

Source: http://ca.news.finance.yahoo.com/s/20062007/2/biz-finance-rising-interest-rates-high-loonie-create-economic-drag.html

At the very least get yourself a rate guarantee from your lender of choice, and if possible wait until after July 10th. It will probably provide the answer as to where rates are going. If they are staying flat, July 10th will probably be flat. If they are going up, July 10th will probably go up.

I’m a fan of locked rates and knowing my payment will be X for Y months. This friday I know my mortgage payment is coming, and I know down to the cent what that payment will be. My next payments are July 6th and July 20th. Both of those will be the same. It’s a personal choice, but I’d rather speculate on something I don’t live in.

According to the blog over at:
http://www.canadianmortgagetrends.com/canadian_mortgage_trends/2007/06/the_b_of_cs_eff.html

A 0.25% rate hike will make a payment on a 100K mortgage (details of calculation at the site) go up by $14.41. If they happen to do a 0.5% hike, even more. I’m always of the opinion that it’s better to know and live for 5 years stress free knowing, even if it does end up costing a little cash. If rates go down over that period I will just lock in longer next time with the lower rate. The lower rates are now, the more likely the fixed will do better over time and I’ll make it all up later.

Since history almost always repeats itself I’d also like to point out the chart here:
http://www.bank-banque-canada.ca/pdf/annual_page52_page53.pdf

Our current rates look extremely similar to the late 50’s. Is another 70’s and 80’s coming? Since the media is allowed using scare tactics to move people to do whatever their sponsors want, maybe I should start a “the sky is falling, but gas prices and interest rates aren’t” campaign.