In 2011 the U.S. debt and euro zone crises sent short-term mortgage costs through the roof. In five short months, discounts on new variable-rate mortgages were wiped out, with rates soaring as high as prime rate. Before that, they were as low as prime minus 1 per cent – a level some said we'd never see again.
That prediction looks like a dud now. We're not there yet but non-bank lenders are already as low as prime minus 0.80 per cent. Barring another global crisis, brokers could be advertising prime minus 1 per cent again next year.
The trend is our friend with fixed mortgages, too. Government bond yields have fallen off a cliff in the last four weeks. The last time yields were this low, discounted five-year fixed rates were 0.10 to 0.15 per cent cheaper than today.
With variable discounts and fixed rates both improving, it's time to re-evaluate today's best mortgage terms. Here's a run-down of two mortgage stars and two dogs:
The three-year fixed Canada's most popular term is the five-year fixed, but most borrowers change their mortgage before five years. Many of those folks face penalties. Many others get stuck paying higher-than-normal rates when they're compelled to refinance with their current lender. A three-year mortgage can sidestep those problems while saving you about one-third of a percentage point versus a five-year fixed. Fixing for three years also provides more rate protection than an adjustable rate. (Typical three-year fixed rates: 2.49 per cent to 2.59 per cent)
The five-year hybrid Economists and the Bank of Canada have wrongly predicted higher rates since 2009. Couple that with the historical edge of variable rates and today's much improved discounts, and floating your mortgage seems pretty appealing. The problem is, no one on this planet knows when rates will climb back to "normal." So, it behooves those with longer amortizations or little equity to respect the risk of higher rates. That brings us back to square one: fixed or variable? Fortunately, term selection doesn't have to be an OR decision. You can choose half fixed and half variable. Just be sure to pick the same term length for each half. In other words, don't take a five-year fixed and a three-year variable. Otherwise, the lender will probably overcharge you when your shorter term renews – since it knows you can't break the longer term without a penalty. The rate diversification of a hybrid mortgage ensures your interest costs won't soar, while delivering interest savings if analysts are wrong (again) about future rate increases. (Typical five-year hybrid rates: 2.59 per cent to 2.79 per cent)
The one-year fixed One year rates used to be exceptional relative to variable rates. Not anymore. Most lenders don't want to compete aggressively in the one-year market because they can't tie you up long enough to make it worth their while. Until one-year rates are again on par with variables, they're good for short-term mortgage needs only. (Typical one-year fixed rates: 2.59 per cent to 2.79 per cent)
Any term over five years Lenders do the happy dance whenever they see someone take a mortgage over five years. That's because the rate premiums on six– to ten-year terms are God-awful. Those premiums more than offset the longer-term rate protection of a six– to ten-year term. If you're that concerned about higher rates, get a smaller mortgage. (Typical long-term fixed rates: 3.60 per cent to 4.39 per cent)
Assumptions: The above picks and pans are based on three assumptions: a well-qualified borrower, an amortization of 10 years or more, and a one percentage point rate hike over the next five years. That latter assumption is necessary because if we knew rates weren't going to rise, variables would overwhelmingly be the term of choice.
Keep in mind, a one percentage point rate hike is quite conservative versus most economist forecasts. So if you're sensitive to payment increases, consider the risk of even higher rates and extend your term accordingly.