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Looking back 5 years.. which mortgage product did your Banker recommend in 2008?

greedy bankerRemember 2008?  It was almost 5 years ago that the U.S. sub-prime mortgage scandal erupted.   October 2008, to be exact.  That’s almost 5 years ago…  And with October and November 2013 renewals being less than 120 days away, we can now lock in some rates for those upcoming renewals.  So I thought this would be a great time to see what sort of advice and recommendations the Banks were giving to their mortgage customers.

THE BANK’S ADVICE

The funny thing is, Banks have never changed their advice or strategy.  ‘Take a 5 year fixed rate’.  That’s all the Banks seem to want to promote.  And with good reason… it’s the most profitable product FOR THE BANKS.   But historically, it’s NOT the best product to take.   There is no historical data that I am aware of that shows taking a 5 year fixed is the best strategy.  But I’ll get into that in more detail later. Continue reading “Looking back 5 years.. which mortgage product did your Banker recommend in 2008?”

A change of strategy… Fixed rates… 5yr or 10 yr?

For years, I have recommended Variable rate mortgages over Fixed rates.   The reasons are simple:

  • Variable rate outperformed Fixed rates in over 88% of the time.
  • You could lock into a Fixed rate at anytime should interest rates go up.
  • you could exit the product at anytime with a maximum 3 month interest rate penalty (compared with Interest Rate Differential penalties for Fixed rates that vary depending on current rates.. we’ve seen 10, 14, 16 and even 20 months interest penalties charged in recent years).
  • If you were in a Variable rate the last 5 years, then you have enjoyed an average rate of around 2.92% compared with a 4.37% fixed rate (annual average rate over last 5 yrs).    It’s been the least expensive way to own your home…  (my clients have saved between 1.45% and 3.00% per year on their mortgages over the past 5 years based on my recommendation).

But then, in August 2011, the Banks caught on.  They decided they wouldn’t offer those great Variable Rates or Prime less 0.75% (3.00% less 0.75% = 2.25%).  They all raised the price on new Variable rate mortgages to Prime less 0.00%.    And this year we have seen 5 year fixed rates hover at around 3.19% to 3.39%…  10 year fixed has also come down to 3.99% and 3.94%.

So what’s the strategy today?  What’s the least expensive way to own your home?     Here are some answers…

If you have Prime less 0.50%  or better, then considering sticking with it.

The fact is, over 80% of my clients are in a Variable rate mortgage of Prime less 0.50% or better.   They have enjoyed huge savings, especially over the last 5 years. I’m not too anxious to have them start paying a higher rate….. Instead of locking into a 5 or 10 yr Fixed rate, why not set your Variable rate payment based on the higher Fixed rates…  You’ll pay more towards principal and pay the mortgage off faster.

If you’re getting a new mortgage or your mortgage is coming up for renewal, then I would consider a Fixed rate term..

This might shock many of my clients and regular readers, but I can’t recommend taking a new 5 year Variable rate based on today’s pricing…  It’s time to look at Fixed rates…  The term will depend on your own personal situation, goals and needs.   5 year fixed (currently 3.29%) is looking like a good choice for many today… But a 1 year fixed (2.89%) might also we a good choice…   One product that is attracting more attention is the 10 year fixed rate (3.89% to 3.94%)… It’s never been under 4.00%… so many people are recommending it… But I’m not so sure about it…. After all, if you were to pay this mortgage out before the first 5 years, you would be faced with a monster penalty!   10, 14, 18 months worth of interest … maybe more…  On the positive side, if you paid the mortgage out after 5 years, the penalty is capped at 3 months interest.

If we compare the 5 yr fixed vs the 10 yr fixed, we can look at a number of different scenarios… but here’s a really simple one to look at…The question is, how much will rates have to increase by in order for you to be further ahead?

If you took a 5 yr fixed rate today at 3.29% but set your payments based on today’s 10 yr fixed of 3.94%, then at the end of the first 5 years, you would have to renew at a rate of 4.75% or higher, before you start to win with a 10 yr fixed rate.     So this is where the unknown comes in to play…  and the unknown can cause fear and panic…     But it can also mean opportunity…  Will interest rates be 2.00% higher than they are today??   Will Variable rate pricing come back to normal and again be the product of choice?  Will there be a new product that is even better than today?    I don’t know the answer… but I think 10 years is just too long of a term to commit to…Things change faster today…   Can we really make plans for 10 yrs?  Remember, if we need to refinance or sell, there is mortgage penalty to deal with….this can blow the savings right out the window…  A lot of what if’s…    I’d probably stick with 5 yr fixed today or go shorter term…

A last thought and point of reflection..

Interest rates have remained below average for the last 10 years…  They have been at record lows over the past 4 years due to the US sub-prime mortgage crisis and the longer than expected global and US economic recovery…..  Interest rates are expected to go up…  the big question is, when??   Regardless of the answer, shorter terms have ALWAYS been a better choice when it comes to mortgages… don’t be so quick to jump into a 5 or 10 year fixed rate… speak with your mortgage broker and get some advice.   Banks want borrowers to be afraid.. they want you to remain unsure…  They want you to lock into the longest term possible because this is where they earn the most $$profit….   Don’t be so quick to contribute the Bank’s profit margin….

The Big Six have all raised their rates now…

A look at locking into a Fixed rate

By now, you’ve heard that Fixed Mortgage rates have gone up by 0.55% since November…5 year fixed is currently sitting at around 4.04% vs 3.49%.  (these are best broker rates…the best retail bank rates are 4.39%)…. Let’s take a closer look at what this will cost you.

On a $200,000 mortgage with a 25 year amortization, your monthly payment goes up by $58.89 or about $3,500 over a 5 year period.    That’s quite a bit of money…. and this probably gets a lot of us thinking about locking into a 5 year fixed rate….But is this the right strategy for everyone?

For some of us, it will make sense to take a 5 year fixed rate… this is not a bad option for those on a tight budget, pension income, or just can’t sleep at night thinking about rates…  make sure you are locking in for the right reason…

A look at NOT locking into a Fixed rate

Current Variable is 2.25%….  A $200,000 mortgage with a 25 year amortization has lower monthly payments by $185.16.  Okay, I know what you’re thinking and you’re right… this rate will not remain the same for 5 years.. In fact, we know it’s probably going to go up.   So it’s difficult to calculate exactly how much you would save or lose by sticking with a Variable rate…  History shows us Bank Prime goes up and down around 2 to 3 times a year….Look at this chart of Historical Rates. The RBC is forecasting for Bank Prime to go up by 1.00% this year and another 1.50% next year!!  (not sure I agree with this forecast).     If you like flexibility, are willing to tolerate rate movements, and want to take a calculated risk of floating your rate, then Variable could be a great option for you.

Is Variable rate more stable than Fixed rate?

The media keeps telling us mortgage rates are going up.. they will skyrocket….So why are people still considering Variable Rate mortgages?   We looked a little deeper and found some interesting trends…

-From Oct 2008 (the month of the U.S. Mortgage crisis) to Oct 2009, the Bank of Canada only changed Bank Prime 4 times…This was the worst recession since the Great Depression of 30’s….and yet Bank Prime only changed a handful of times….

-the BOC raised rates in 1992 because they thought the economy was strong enough to handle… they quickly lowered them but it was a little late as the economy staggered for another few years… this pattern has repeated itself on more than one occasion…most recently, 2010…

-the BOC forecasted that interest rates would skyrocket in mid to late 2010… they were wrong…

-Variable rate has historically been 1% to 3% lower than fixed rates.

Conclusion….Variable rate moves less often than Fixed rates… And yes, it’s more stable if you measure stability by rate movements… But there will be movement.. and maybe that’s what makes Variable rate a choice for only 25% of Canadians…  Us Canadians are a conservative bunch, or so our rep goes….  And by the way… The Banks would LOVE to have everyone take a 5 year fixed rate.. these are the most profitable mortgage products for them…. Keep that in mind…

Bank of Canada action not always prudent or correct…

Have to share this article giving us some history on the accuracy of the Bank of Canada (BOC)  interest rate forecasts…   This should get you thinking a little the next time you hear the  BOC forecasts…. Take a look at this Historical Rates chart.. look at the Bank Prime section…   You will notice some trends of rates hikes followed by rate drops…

We aren’t saying BOC rates will fall anytime soon… it’s clear the rate will go up…. but there is no straight line increase if you look back in history… Increases are followed by decreases…

-1992.. the BOC erred and raised rates thinking the economy was strong but they quickly retreated and reversed those increases after realizing it was too much, too soon.

-1995…the Quebec referendum year… remember that?  I do.. I bought a house that year… and interest rates went up 1.00% overnight after fears of a Quebec ‘YES’ vote was more than possible… but then rates dropped like a rock and remained low for several years…

-2000….another recession… the dot.com, dot.bomb error of hi-tech stock greed…  rates had climbed in 1998 and 1999 but dropped in 2001 and remained low once again…

-2008…the U.S. mortgage crisis… the worst Global recession since the Great Depression of the ’30s…. we saw BOC drop the rate to a modern-day record low…Bank Prime was 2.25%…

-2010…the BOC kept it’s promise to raise rates and increased the rate by 0.75% over a 3 month span to 3.00%….

-2011…. ?????  the BOC is expected to raise rates by as much as 1.00% this year, and another 1.50% next year, according to the RBC Economist…. Did the BOC raise rates too quickly?  Can our economy absorb these increases?   Questions that won’t be answered for a while…

It doesn’t mean you have to sit and do nothing

But this doesn’t mean you have to stand by and be a spectator.   By keeping informed with historical trends and understanding your own personal situation, you can be in control…. Understand where you fit in… Is Fixed rate better for you now?  Does Variable Rate still make sense for you?   Can you handle the potential increases that are coming?    A good Mortgage Broker can help guide you to the right answer… Remember, it’s your mortgage, your payment…your decision.

Mortgage Rate history…25 year chart

Here’s an updated 25 year Interest Rate Chart.   The chart gets updated monthly by Firstline Mortgages, a division of CIBC.   Click here to see the data.

The only surprise is that interest rates didn’t go up as many experts had predicted last year and earlier this year…  To sum up why in just one word……UNCERTAINTY…..  there is a lot of uncertainty about he global recovery and the domestic economy…. watch for interest rates to stay fairly flat through the rest of 2010….

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