From the Globe and Mail – Variable or Fixed? Both options have merit
My colleague from Ontario, and someone whom I truly admire, Peter Majthenyi discussed long term versus short term rates with the Globe Investor. I have done my own research as to whether fixed or floating is the best option right now, and have written a chapter on it that you can preview soon by signing up for the F Your Mortgage privileged information list. It turns out the benefits of fixed vs. floating have little to do with rising rates, and more to do with another little known factor that you can read about by signing up. You can also get the Dirty Little Lender Secrets Chapter.
See what Peter and another Ontario broker have to say about long and short term rates below.
“There’s not a right or wrong choice,” replies Peter Majthenyi, a mortgage planner with Mortgage Architects in Toronto. “It’s capturing the temperament and risk tolerance of the client.”
These days, those of Mr. Majthenyi’s customers who prefer a locked-in rate are commonly going with 10-year mortgages at 5.3 per cent. That compares with his best rates of 3.79 per cent for a five-year mortgage and 1.95 per cent for a variable-rate loan.
With a 10-year mortgage, you’re entirely insulated from the coming cycle of interest rate increases. Over that period, Mr. Majthenyi notes, your income will rise and you’ll pay off a lot of the interest on your mortgage. At renewal time, you should be in a good position to make higher mortgage payments if need be.
The 10-year rate of 5.3 per cent seems high in comparison with current five-year rates, but it’s reasonably attractive if you look at the past decade. The average five-year rate posted by the big banks over that period was 6.78 per cent, according to Bank of Canada data. If we discount that rate by 1.5 percentage points, we get a real-world average, five-year rate of 5.3 per cent.
To give the other side of the argument about long-term mortgages, let’s hear from mortgage broker Jim Tourloukis of Advent Mortgage Services in Unionville, Ont. He points out that the higher rate for the 10-year mortgage would potentially cost hundreds of dollars more per month.
“That’s a big insurance premium to pay,” he said. “Peace of mind is important, but you can get that with a five-year mortgage.”
Worried that you’ll have to renew at much higher rates in five years’ time? Mr. Tourloukis said you can work around this by jumping into a one-year mortgage on renewal.
You can now get a rate of prime minus 0.1 to 0.3 of a percentage point. The net result for some borrowers is that they could chop their rate by a full percentage point if they were to break their current mortgage.
Mr. Tourloukis said it can be cost-effective to do this, thanks to a quirk in mortgage fine print. The penalty for breaking a variable-rate mortgage is three months’ interest – period. With fixed-rate mortgages, lenders charge the greater of three months’ interest or an “interest rate differential” (IRD) that compensates them for interest lost as a result of you breaking your mortgage.
Lots of people have tried to break existing mortgages and been deterred by astronomically high IRDs. Mr. Tourloukis said it’s plausible that someone who took out a $300,000 variable-rate mortgage last May might face a penalty of something like $2,200.
