Even the big boys are stumped by the question of what to do about mortgage rates right now.
Fixed-rate mortgages at the big banks soared late last week by as much as 0.85 of a percentage point, which, by the usual standards of rate changes, is somewhere between really, really big and humungous. When was the last time we saw such a significant shift in mortgage rates? Oh, a little less than a month ago, when banks cut their rates by as much as 0.85 of a point.
What makes these changes all the more confusing is that, exceptional as they are, they're starting to look familiar. Early last summer, rates were set to rise because of strong economic growth and the need to keep inflation under control. Then financial markets came undone and rates were reined in to ease the strain. We then moved into a declining rate phase, where the concern was a slowing economy. Now, the rate outlook has changed yet again.
"In global markets, we've had a sea change in sentiment in the past month or so," said Douglas Porter, deputy chief economist at BMO Nesbitt Burns. "There has been a monumental shift away from seeing weak growth as being the top risk. Higher inflation is now seen as public enemy No. 1."
The threat of higher inflation ultimately leads to higher mortgage rates. How do you react if you're buying a home or renewing a mortgage in the months ahead? It sounds counterintuitive, but a variable-rate mortgage could be the answer.
Before we explore how this might be so, it has to be said that locking into a five-year mortgage right this minute is not a bad play. In fact, some lenders may still offer comparatively good deals on this term. "One of our lenders has just given us a really phenomenal discounted rate on a five-year mortgage - 4.99 per cent," said Kim Arnold, a mortgage broker with the Dreyer Group in the Vancouver area. The posted big bank five-year rate yesterday was either 6.95 or 7.15 per cent, while alternative lenders were around 5.5 per cent.
The appeal of variable-rate mortgages is that you can get them right now in the area of 4.15 per cent, which you arrive at by taking the big bank prime rate of 4.75 per cent and applying an average discount of 0.6 of a point.
There's a rough consensus that the cost of variable-rate mortgages is going to rise at some point in the next six to 12 months. The Bank of Canada signalled this last week when it faked out all the analysts who were expecting a rate cut and instead left rates untouched. The bank's rationale: Inflation is starting to pose a threat and it's no longer appropriate to cut rates.
How long before the bank raises its benchmark rate and in turn causes lenders to increase their prime rates? Mr. Porter said BMO's take is that it won't happen until next year because of lingering economic softness. But let's say the bank raises rates by a quarter or half point by year's end. A typical variable-rate mortgage might rise to 4.65 per cent, which is still substantially less than any five-year rate you're likely to get right now.
In fact, the prime rate would have to rise by more than a full percentage point for most people going with variable-rate mortgages today to be in a worse position than if they chose a five-year mortgage.
Ms. Arnold says there's a way to get extra benefit from going with a variable rate right now. Some lenders are offering special deals on these mortgages, where borrowers receive a discount of one to as much as 1.3 points off prime for the first year of a five-year term (you get a minimal discount for the other four years). If you're planning to stay in a variable-rate mortgage for the full term and not switch to a fixed rate, don't take this offer. You'll do better to get a standard discount that lasts for the full five years.
It's a different story if you see yourself converting into a fixed-rate mortgage when the prime rate starts to rise. Here, you could take advantage of a big upfront discount on a variable-rate loan and have as long as a year at something like 3.75 per cent or less. Ms. Arnold said the savings from taking this approach would likely outweigh the cost of locking into a five-year rate that was higher than those available today.
If you prefer the calm of a fixed-rate mortgage, then don't be in a rush to make a commitment. BMO's Mr. Porter says the recent surge in interest rates may have gone a bit too far, which raises the possibility of a modest downward adjustment.
Then again, interest rates could then fake us out yet again and start to fall instead of rising as now expected. Borrowers should be so lucky.
