A recent Bank of Montreal study says that variable-rate mortgages have worked out to be better than fixed-rate mortgages 83 per cent of the time since 1975.
I believe we are now in the 17-per-cent zone.
Here are three key reasons:
Protect yourself from interest rates you can’t afford Today, Canada’s debt-to-income ratio has reached 150 per cent – an all-time high. To me, this is rational. If you can borrow money at 2 per cent or 3 per cent, it can make financial sense to borrow a lot.
The big issue is whether these same borrowers would have borrowed as much if interest rates were 5 per cent or 6 per cent. Based on the history of five-year mortgage rates since 1950, it is rare to get a 5-year fixed mortgage for under 6 per cent.
We don’t know where interest rates will be over the next five to 10 years, but what percentage of borrowers today will have financial difficulty paying their debt at 6 per cent? For those that will be in rough shape in that scenario, a variable-rate mortgage today is a real risk.
The only way someone can eliminate that risk is to lock in their mortgage rate. Today, you can get a five-year fixed mortgage for as low as 3.2 per cent. While you still need to worry about where interest rates will be in five years, you will be protected from any interest rate increases until late 2016.
For those who are truly risk averse, you can get a 10-year mortgage today for 4.69 per cent. While a 10-year mortgage is not the right solution for many people, for some stable and risk-averse people, this could be an ideal solution to avoid any interest rate risks for a decade. Keep in mind that for most of the last half century, a mortgage rate of 4.69 per cent would have been a blessing.
The premium on fixed mortgage is very small For most of the past year, Canadians have leaned very heavily to variable-rate mortgages. Earlier this year, five-year variable mortgages were being offered at rates as low as prime minus 0.95 per cent (2.05 per cent at current prime rates). With the latest financial worries, lenders have raised variable rates. It is now difficult to find better than prime minus 0.5 per cent on a five-year variable mortgage. At today’s prime rate, this translates into 2.50 per cent.
Traditionally, a five-year fixed-rate mortgage would be 1 per cent to 2 per cent higher than the five-year variable rate, depending on the prevailing yield curve. The yield curve shows the difference between short-term rates and longer term rates.
Today, if you can get a variable rate mortgage for 2.50 per cent, and a five-year fixed at 3.2 per cent that is just a 0.7-per-cent premium. That is a steal on a historical basis.
Now factor in the fact that today’s prime rate is among the lowest in history and there are very few people who believe that interest rates will be the same or lower three years from now. If ever there was a time to take a hit of 0.7 per cent (on the front end) for the benefit of having a locked in rate for five years, today might be the day.
Peace of mind There are a lot of things to worry about in life. For those with a large variable-rate mortgage, I know from our clients, that every Bank of Canada interest-rate announcement brings some anxiety. Having a fixed-rate mortgage simply eliminates that extra worry for at least a few years.
On its own, peace of mind is not a strong enough reason for most people to go fixed versus variable, but in combination with interest-rate history and the exceptionally low premium for a five-year fixed-rate mortgage, I believe now is the right time to lock into a fixed-rate mortgage.
Even if you are currently in a variable rate mortgage that doesn’t come due for a while, now might be a good time to consider moving to a fixed-rate mortgage and locking in the lowest rates in history.
We may just look back at today’s fixed rates and wonder how we could have ever considered not locking in.
Ted Rechtshaffen is president and CEO of TriDelta Financial Partners, a firm that provides independent financial planning advice. He has an MBA from the Schulich School of Business and is a certified financial planner. He was vice-president of business strategy at a major Canadian brokerage firm.
Follow Ted on his blog at The Canadian Financial Planner.