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Mortgage Matters


Blog by | June 16th, 2009


IS IT TIME TO LOCK IN?

ROB CARRICK

00:00 EDT Tuesday, June 16, 2009

Jas Grewal's reaction to the recent runup in interest rates was to abandon a sweetheart of a variable-rate mortgage in favour of a safer, but more expensive, fixed-rate mortgage.

Mr. Grewal, you should know, is a mortgage broker. A mortgage broker who sees the potential for much higher rates in the future.

"I'm fairly conservative and I'm locking in," said Mr. Grewal, of the Mortgage Centre in Toronto. "Rates are starting to spike and I think they're going to continue."

Variable-rate mortgages like the one Mr. Grewal has are unaffected by rate increases over the past couple of weeks. But fixed-rate mortgages are on the rise, and he's worried about a pervasive trend toward higher borrowing costs. He may have a point -- it may be time to bail on that variable-rate mortgage and lock in for the longer haul.

Ultralow rates are a big reason why there are signs of life in the housing market. Sales activity and prices are have been rising this spring; the average resale price of a home sold in May was nearly $320,000, according to the Canadian Real Estate Association, bringing prices back to where they were before last fall's financial meltdown.

But rates are ticking up again. Five-year mortgages with a juicy discount are now going for about 4.3 per cent after two recent rate increases that lifted them off historical lows in the 3.7-per-cent range.

Meanwhile, the prime rate, used as a base rate for variable-rate mortgages, continues to sit at 2.25 per cent.

Mr. Grewal's concern is that rising inflation will send short-term interest rates soaring to a point where a five-year mortgage at today's rates will look like a comparative bargain.

Statistically, variable mortgages are a better deal than fixed mortgages 88 per cent of the time, Mr. Grewal said. "But I think we're in that 12-per-cent zone right now."

Whether you're thinking of locking a variable rate into a fixed-rate mortgage or of renegotiating a mortgage you took out years ago to benefit from lower rates today, you have some thinking to do about rising borrowing costs.

There's no consensus that the worst of the global financial crisis/recession is over. Yet, financial markets are starting to consider the risk that inflation will be stoked by all the stimulus that governments are injecting into the economy. The result is that interest rates are starting to creep higher in the bond market, which influences the cost of fixed-rate mortgages.

"The general trend toward higher rates, and away from those extreme lows we saw at the turn of the year, is likely to be the dominant theme over the next year as the global economy and global financial markets heal," said Douglas Porter, deputy chief economist at BMO Nesbitt Burns.

It's important to understand that there are two tracks for interest rates. One is the bond market, where investors tend to sell bonds when they see higher inflation and interest rates coming and to buy bonds when they see rates falling or are petrified with fear about a global financial meltdown. That's what's happened in the past nine months or so.

The second track is the one the Bank of Canada influences through its overnight rate, which has a major impact on the prime rate charged by the banks to their best customers. The prime, in turn, is the key to variable-rate mortgages.

The two interest rate tracks do not run parallel right now. The Bank of Canada said in April that it would keep its overnight rate steady for as long as a year if required to steady the economy, and last week central bank Governor Mark Carney said there's a risk in removing support to the economy too soon. BMO's Mr. Porter said it's possible that the Bank of Canada could start raising its benchmark rate in the early part of next year. So here's the question if you've got a variable-rate mortgage: Do you jump into a five-year rate that is still close to historical lows, even after the recent move up, or do you coast?

Mr. Grewal has gone with the first option, and you can see his commitment to this stance in the fact he's giving up on a variable-rate mortgage with a whopping discount of 0.9 percentage points off prime. When the financial crisis bit, banks changed their policy of offering discounts off prime and started selling variable-rate mortgages at prime plus as much as one to 1.5 percentage points.

Lenders offering variable-rate mortgages generally allow customers to lock into a fixed-rate mortgage at no charge, but Mr. Grewal is going a different route. He's breaking his mortgage, paying a penalty and moving to another lender. The reason: His new lender is holding a five-year rate of 3.69 per cent for 120 days, which means he can enjoy the ultralow rate on his existing mortgage a bit longer before jumping into the security of a fixed rate.

There's good reason to use the same strategy if you're breaking a fixed-rate mortgage. If rates rise during the period your new rate is being held, the penalty you'll have to pay should decline. Remember, these penalties are tied to the difference between the rate you got originally and rates of the moment.

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