Should you lock in your variable rate?

Today we’re going to talk about variable rate mortgages & whether you should lock in. Earlier this week I put out a blog which dove into fixed versus variable & outlined some of the key factors which could impact rates one way or another. We also looked at what history suggests is the best strategy, so for anyone who wants to take a bigger bite out of this, I’ll link to that in the show notes below but this video is going to build off that & give some practical questions to ask yourself if you’re debating whether to lock in your variable.

When ppl talk about fixed vs variable, you’ll often hear them saying a fixed rate mortgage is for the risk averse, as you know exactly what your payments are going to be for the length of your term. In reality, though, the biggest downside of a fixed rate mortgage is the penalty. If you break the term, which happens to the vast majority of borrowers, there is a penalty attached & on the fixed rate side the penalties have the potential to be much much much higher than with a variable. Given that most ppl end up breaking their term & paying that penalty, taking a fixed rate comes with more downside risk than a variable & when you consider that the variable has outperformed the longer term fixed rates close to 90% of the time, the variable actually seems to have much less risk than a fixed. If you’re in a variable currently, keep this in mind. The decision of whether to lock in should weight the probability of potentially breaking the mortgage just as heavily, if not more heavily, than concerns of rising rates.

Moving on, if you’re 10000% certain you will not be breaking your mortgage & therefore are not concerned with penalty risk, the question of locking in really boils down to your own piece of mind. If talk of rates rising keeps you up at night, or if your budget is tight & increases to your payment are going to but strain on your finances, then the first thing you want to do is contact your lender & ask what your options are to lock in. Compare the difference in payment & see what your buffer is – how many Bank of Canada increases would it take before that variable catches up to the fixed? If one increase is going to bring you to par, then that decision is going to be easier than if it would take 3 increases. Compare the risk & reward. Think of it as an insurance policy against rates really taking off.

With all this said, I’d like to again point out that history suggest locking in a variable isn’t a great idea from an overall cost of mortgage perspective. You’re better off just riding it out. For more info on that, again I’d recommend reading the blog I put out earlier this week, or feel free to give me a shout.

Ryan Zupan
Mortgage Planner
DLC City Wide Mortgage Services

Should you lock in your variable rate mortgage?

The past 8 months have seen the most rate increases by the Bank of Canada in over a decade.

Amidst worries of inflation finally starting to creep in with our American neighbors, and concerns that, after 35 years of declining rates, this long term declining rate trend may finally be reversing, the question of whether to lock in that variable rate that has done so well for borrowers has become a valid concern. In this blog we’re going to give some perspective to these rate increases, outline reasons for & against future increases & discuss the questions you should ask if considering locking in your own mortgage.

We are currently just off the basement of a multi decade long term trend of declining interest rates, which began in 1981 when prime rate dropped from its high of 21.25%. Since then, the overall course has been down & we have hit historical lows for interest rates in what has been an unprecedented experiment in central bank policy. In fact, over the 5000 years of interest history, the world is at the lowest level ever recorded. From that perspective, one would assume we’re closer to the end of this long term cycle than the beginning, but the question is what is going to happen in the near term.

Central bankers use interest rates as the levers of the economy

– lowering rates incent borrowing which leads to spending & investment, while raising rates are used to slow the economy & reel in inflation. While Canada had a far better year than expected in 2017, we are facing some major headwinds to overcome in the year ahead. For one, rising rates slows housing, which has been a big driver of the economy to this point. Higher rates can also strengthen the loonie, which negatively impacts exports & therefor manufacturing.

There is also the overall indebtedness of Canada to consider. Too many rate increases too quickly can effect repayment of loans & put Canadians under water on their debts. Additionally, NAFTA renegotiation & the lowering of the corporate tax rate in the States (making Canada less competitive) are two other pressing concerns for our economy. Overall, there is anything but an assured path to aggressive tightening of interest rates in the short term.

To get a sense for where rates might be heading, we can look to the yield curve.

The yield curve plots short to long dated government bond yields (interest rates are priced off of these bond yields). A normal shaped yield curve is upward sloped & indicates investors expect longer maturity bond yields to be even higher in the future. Despite the short term yields rising roughly 1% over the last year in Canada, long dated bond yields have barely moved. The yield curve is still relatively flat, which suggests investors are not optimistic for long term growth & therefore skeptic to see higher interest rates.

The best research on fixed versus variable has come from York University professor Dr Moshe Milevsky. He found that borrowers were better off taking a variable rate over a longer term fixed rate nearly 90% of the time. Fixed rate borrowers pay for stability, while those with a higher risk tolerance, who can handle fluctuations to their payments, would benefit from that uncertainty by paying less interest. Years later he updated his study to determine if borrowers would be better off trying to time the market & lock in their variable mid-term. Even under the generous & unrealistic assumption that borrowers would be able to accurately forecast the future of interest rates, he found that individuals who attempted to lock in & time the market underperformed (83.3%) those who stuck with the variable (88.1%) & rode out their term.

Accurately predicting interest rates is one of the hardest things to do in all of finance.

You could be right in timing the bottom of this 36 year trend within 5% & still be off by 22 months. Given that fixed rates are priced off bond yields, and that the bond market has generally priced in increases by the Bank of Canada before they have happened (meaning fixed rates will go up before you’ll hear talk of prime rate increasing), don’t bother trying to time the market. Take a fixed term mortgage & sleep easy knowing exactly what your payments will be for the coming term, or take the variable & don’t worry about the impossible task of trying to time the market. Choose a path & stick with it.

Why you qualify for less going with a variable: Qualifying for fixed/variable

One of the more common questions I get asked is fixed or variable?  Which is better?  Well, qualifying for the 2 is not the same so the first question you should ask is, do I qualify for both fixed & variable because it is more difficult to qualify for a variable than a fixed rate.

A variable rate mortgage has more risk than a fixed rate.  Because your rate & payment fluctuates, the bank wants to make sure that, when rates go up, you have enough income to cover that increase.  So when you qualify for a variable, instead of basing the formula on that juicy low variable rate of 2.2%, they’re going to use the 5 year qualifying rate, which is 5.49%.

That’s quite a difference in rate.  I want to give you an idea of what those numbers mean, so let’s say you earn $60,000, have no debts &, for illustrative purposes, we’re going to ignore the costs of ownership like taxes, heat, strata fees, etc.

Qualifying with today’s best 5 year fixed of 3.69%, <20%, on a 25 year, you would be eligible for a mortgage of roughly $340,000.  Now, using those same numbers, going with a variable & using the qualifying rate of 5.49%, that same client is eligible for a mortgage of around $285,000 – 15% less.

So this is important to know.  If you’re looking at homes in the north end of your affordability range, you may not have a choice.  A 5 year fixed may be the only way you can purchase.

Now, you do get a break if you have 20% down or more.  Because you have more equity in the home, most lenders allow you to qualify using the 3 year posted rate, not the 5 year, which will improve your qualification limit.

To find out how much you qualify for going with a fixed or variable, contact me.

Ryan Zupan
Mortgage Planner


What controls fixed rates?

Hi, Ryan here with the Mortgage Centre City Wide. I know we’re really going through the basics here & breaking down the topics of these videos to their most basic form, but a fixed rate mortgage is really, well, very simple. Your interest rate & mortgage payment are fixed throughout the length of your term. Of course, you can fix your payments at a higher level, but that minimum monthly amount & the rate that’s based off of are fixed for your term.

So, I think a better topic here is explaining what drives your fixed rate mortgage, or, how do banks determine their 5 year mortgage rate. Remember, in my video on what controls your variable rate, we learned that the Bank of Canada is in the drivers seat. Well, fixed mortgage rates are determined by the market & are based off of government bond yields. Why?

After mortgages are arranged, they are packed up & sold on the markets as Mortgage-Backed Securities (MBS). These investments are similar to government bonds and actually compete against each other as low-risk investments. So when the yield on the 5 year bond increases, investors are attracted away from Mortgage Backed Securities to the corresponding bond because, now, the bond has a higher yield. To become more competitive, then, lenders will increase fixed rates & vice versa.

So the final question we have here is why do bond yields increase or decrease? The coupon for the bond, or the income that bond produces, is fixed, so why would someone want to pay more or less for that fixed income?
Well it’s driven by supply & demand. When the stock market is in turmoil, people want a safe place to put their money, so they may go after bonds. The more people wanting to buy bonds, the higher the price increase &, in turn, the more the yield decreases.

This is probably getting into another topic but bond yield & price have an inverse relationship. All you really need to know is when the markets are volatile, the yield on bonds decrease & therefore fixed rates will decrease. On the other side, when the markets are strong, investors are attracted away from bonds, their price decreases, yield increases, as will fixed rates.

Now typically, the spread between the bond yield & the corresponding fixed rate is 1.2 — 1.4%, but fixed rates are kind of like gas prices, they’re quick to go up but slow to trickle down. So if you want to get an idea of when 5 year fixed rates are going to increase, keep an eye on the 5 year bond yield. Or call me.

Ryan Zupan
Mortgage Planner

What controls variable rates?

Last week, we went over what is a variable rate. Today we’re going to go one step backward & explain where that variable rate comes from.

Going with a variable, you are opening up your mortgage to a lot more risk than with a fixed rate. Of course, because your rate changes throughout the year, there is no limit to how high this rate could go throughout the term. So, it’s very important for those going with a variable, to understand who or what controls Prime Rate & how they can get an idea of where their rate is going throughout the term.

Your variable, remember, is tied to the bank’s prime rate, so what determines prime rate?

Prime rate is controlled by the Bank of Canada’s overnight rate; they are directly related. 8 times per year, the Bank of Canada announces whether they will increase, decrease or leave target for the overnight rate unchanged. This is an important announcement for those with variable mortgages because this will tell you what’s going to happen to your mortgage for the next month or two.
Why would the Bank of Canada change the overnight rate, or in turn, Prime Rate?

This is really a tool the Bank of Canada uses to control inflation & the economy. When the economy is strong & the price of goods is increasing, inflation begins to happen. To try to slow down inflation, the Bank of Canada will increase this rate to get the economy under control. Higher interest rates means it’s more expensive to borrow. When it’s more expensive to borrow, you can expect less borrowing to happen, so less stimulus to the economy.

On the other hand, when the economy is slow, as we saw the Great Recession beginning 2007, the Bank of Canada wanted to encourage borrowing to ignite the economy. In this case, they lowered the target for the overnight rate to make it more attractive to borrow. Lower interest rates means it costs less to borrow. If I’ve been holding off on buying, when the government lowers that rate, it might just be enough incentive for me to take out that business loan, or buy a house, or whatever; it’s more attractive for me to borrow.

So with your variable rate mortgage, Prime Rate is not some magic number your bank uses to punish you or anything like that, it is determined by the Bank of Canada, which is basing its decision on the economy.

If you’d like to know more information on this topic or if you’d like to know where economists are predicting prime rate to go over the next 2 years, contact me.

Ryan Zupan
Mortgage Planner

Fixed/Variable 101: What is a variable rate mortgage?

Hi Ryan here with the Mortgage Centre City Wide. Today, we’re starting a new series of videos on the fixed/variable — qualifying for, penalties with, which is better — basically, any question you can think of related to these topics, I’m going to cover so tune in during the upcoming weeks.

Today, though, we’re going to start today with the basics — what is a variable rate mortgage?

With a variable rate mortgage, as you can guess from the name, the interest rate changes throughout the term. Your interest rate is going to be tied to the bank’s prime rate. You’re going to have some kind of discount to prime. Right now, a good discount is prime — 0.8%. So no matter where prime goes throughout the term, you’ll always be 0.8% below that mark. Right now, prime is 3%, so your rate starting out will be 2.2%. Now, if the big banks’ economists are correct & prime increases to 4% by the end of this year, your rate at that time will be 3.2%.

Now, there are open variable rate mortgages & closed variable rate mortgages. With open mortgages, you can pay the mortgage out at anytime, without a penalty. With closed variable, if you want to exceed your prepayment privileges or end your mortgage early, you have to pay the penalty. Generally speaking, unless you’re planning on selling the home in the very short term, as in, a few months, it’s better to go with a closed variable. The reason being, with an open variable, instead or prime minus, you’re looking at prime plus 1%. So instead of 2.2% (closed), you’re looking at 4% (open). Because the interest rate is so much higher & you’re paying so much more interest compared to a closed variable, it’s likely going to be better to pay the penalty & go with a closed.

There are 2 types of closed variable mortgages — fixed payment & fixed amortization. With fixed payment variables, obviously your payment is the same each month but when your interest rate rises, your amortization increases. Conversely, when your rate decreases, your amortization decreases. This is great in a declining rate environment because your amortization will shrink down without you having to pay more money each month. HOWEVER, in a rising interest rate environment, like the one we’re facing today, this is generally not something I’d recommend because your amortization may increase to the point of getting you in trouble.

With fixed amortization variables, when your interest rate changes, so does your payment. If you want a fixed payment, I urge all my clients going with variables to do so but fixed it at a higher level. Watch my “variable rate mortgage strategy video” for more info on this.

That’s our very basic breakdown of the different types of variables out there, watch my next video on what controls your variable rate mortgage.

Ryan Zupan
Mortgage Planner

How to best take advantage of today’s low variable rate?

Ryan here with City Wide Financial, talking about what is an adjustable rate mortgage strategy.  This is one of the more common questions we’re asked – fixed or variable, which is better?

If you are asking yourself this question, a strategy I encourage you to think about is taking an adjustable rate, but fixing your payments at what they would be at the higher, fixed rate level.  If you’re considering taking a fixed rate, you can obviously handle that payment, so why not fix your payment at that level & pay down boatloads of principle while the variable rate is so low.

A good variable rate is around 2.25%, about 2% below today’s best fixed rates.  On a $300,000 mortgage over 30 years, your variable rate payment is over $300 lower than the fixed payment.  So if you take the variable rate & fix your payments at the fixed rate level, in year 1 you’ll pay down $4000 in more principle than you would normally.

Now, of course, the variable rate fluctuates & as it increases, the savings won’t be as significant but my goal here is to illustrate the kind of savings you’ll see.  Also, eventually that fixed payment likely won’t be enough to cover your variable payment, so at that time you’ll need to fine tune your strategy, but that is why you need someone committed to managing this mortgage for you.  Taking a variable rate opens your mortgage up to a lot more risk & anyone thinking of taking a variable rate with their bank is crazy because they do nothing to manage your mortgage over the term.

A lot can happen in 5 years time, particularly in the mortgage world, is money, so it’s important to have someone advising you throughout the life of your mortgage, making sure you’re saving as much money as possible.

If you’d like to hear about more of my mortgage strategies, or to see how much you can save by taking the adjustable rate strategy, contact Ryan at City Wide Financial.

Ryan Zupan
Mortgage Planner