The homebuyer's dilemma: short-term or long?
The great rate debate
The homebuyer's dilemma: short-term or long?
Helen Morris, National Post
When finances are tight, it's good to plan ahead and have a clear idea of what your future expenditures will be. One of the standard ways to plan a budget is to base your monthly expenditures on your mortgage payment and fit other expenses around that. A fixed-rate mortgage gives you set monthly payments for anything from one to 10 years, allowing for a stable financial plan. There are currently five-year deals available at about 4%. On the other hand, if you are strictly looking for the lowest payment possible and feel you are able to tolerate the risk of a future rate rise, then you may choose a variable rate.
"The lowest variable is prime [2.25%] plus 0.3% and it goes up to prime plus 0.6%. It's so low that it's only going to eventually go up," says Paula Roberts, a mortgage broker for Mortgage Intelligence in Unionville. "What's most important is if clients want to take advantage of the prime plus, say, 0.5%, they need to be prepared that if prime goes up to 4%, their rate goes up to 4.5%."
The Bank of Canada has signaled it is likely to keep rates unchanged until June 2010. This means an existing variable deal linked to prime is stable for the time being, but rates on new fixed-term deals (which are based on bond yields rather than prime) are rising.
"It does make the decision a little bit difficult ... where one is apparently locked for at least another 11 months and the other one is slowly creeping up," says Michael Gregory, senior economist at BMO Capital Markets. "The differential has become quite wide ... so you are paying what would appear to be a pretty hefty insurance premium[if you choose a fixed rate] to guard against higher variable-rate mortgages."
Both Ms. Roberts and Jim Murphy, president and CEO of the Canadian Association of Accredited Mortgage Professionals ( caamp.org),recommend checking the fine print on a new variable mortgage to ensure it permits you to lock in at a fixed rate when variable rates start to rise.
For refinancing an existing mortgage, Mr. Murphy cautions that the penalty for an early payout will likely outweigh any gains in reduced interest.
"If you're only in the first year or even the second year of a mortgage ... generally speaking, the penalty is going to be much higher," says Mr. Murphy. "You've really got to sharpen your pencil and do the math and make sure that you're getting an advantage." Penalties are generally three months' worth of interest payments or the interest rate differential on the balance, but check the fine print.
And the decision to switch also depends on where in your current mortgage term you are. Ms. Roberts says clients who have less than $100,000 to pay off may be more tolerant of rate rises than a client who is at, say, the start of paying off a $400,000 loan and may want to lock into a predictable fixed rate.
Ms. Roberts recommends that, if you do sign on to a new variable rate mortgage, you set your payments as if they were at a fixed rate of, say, 5%.
"More money is going to principal, and when you lock in at 4.5%, it's no shock to your payment," says Ms. Roberts. "The last thing anybody wants is to have to sell their house because they can't afford it."
As for deciding the best moment to lock in? There are no easy answers.
"There's been a lot of stimulus. Maybe we will have inflation problems, in which case central banks will have to raise rates quickly and aggressively to try to cool that," says Mr. Gregory. "That is one risk you'll face with certain variable rates. It's definitely a hard choice for consumers."
