So what does this mean to all the house hunters out there? Ms. HHV, one of the most cautious financial managers I know, is all over variable rate mortgages these days. She loves 'em. Why you ask? Well simply put, they save you money. And a lot of it. But as all things that save you money come with, a note of caution: you gotta fit the economic fundamentals to take advantage of this.
I'm going to extensively quote an economist rather than give you a knee-jerk explanation here.
See where you fit into his advice.
- The first-time homebuyer and especially those who placed minimal initial down payments with high leverage ratios, are the ideal candidates for long-term fixed rate mortgages. These folks should not be taking any chances with a fluctuating interest rate. In fact, they might be hit with a double whammy if the value of their (overpriced) house declines leaving them with negative equity. To them I say,“count your blessings, don’t be greedy and lock-in at a fixed rate.”
- The risk-averse worrywart who is constantly looking at interest rates and wondering if ‘now’ is the time, should do what all risk-averse investors do: diversify. Indeed, there is a strong argument to be made for diversifying your mortgage debt, similar to the prudent strategy with your investment portfolio. Now, in general, diversifying your debts is a silly idea since you should put all your eggs in the one basket with the lowest interest rate. But, I do agree that split rate mortgages make some sense in today’s ultra-low environment. The ideal strategy is to partition your mortgage in two halves, one linked to a variable rate and the other closed for a longer period of time.
- The seasoned veteran, possibly with two stable breadwinners in the family and with a substantial amount of built-up equity in the house should still follow Shelly Short’s strategy. They can afford the risk and continue with a variable rate mortgage, making payments based on a high fixed rate schedule. This is an easy way to (think you) have your cake and eat it too. From a purely psychological point of view -- as long as you pick the payment rate to be 1% to 2% above the initial floating rate -- if and when interest rates do start to increase, it should have no noticeable impact on your monthly budget.
- The financially savvy arbitrageur can do even better. Most banks allow you to pre-approve a fixed rate mortgage for between 90 and 120 days. You are guaranteed the pre-approved rate regardless of what happens to mortgage rates over the next 3- 4 months. This is the closest thing to a free lunch (actually, call option on interest rates) you will ever get from a Canadian bank. If you have a floating (open) rate mortgage that allows you to pre-pay any amount anytime without penalty, then walk across the street to your bank’s competitor and ask for a pre-approval on a 5-year fixed rate mortgage. Then, keep a close eye on the Bank of Canada and the bond market. If rates increase tomorrow, exercise your free option and move your mortgage across the street, at yesterday’s rate. Otherwise, do nothing and start the process over in a few months. Understandably, the branch manager might get a bit weary of your constant requests for pre-approval…
Until people are desperate to sell we won't see significant overall reductions. With all the unsold condos coming online in the fall, maybe we'll see something significant in that market when interest rates hit 5% in October/November?