The age old question facing consumers, do I take a fixed rate or variable rate……and a similar dilemma facing mortgage brokers as their clients ask them for advice on which option to take. We all know it depends on the client’s appetite for risk, affordability, cash flow stability, etc. however statistics have shown that taking a short term or variable rate has predominantly, but not always, been cheaper than take a longer fixed rate mortgage.
We maybe in or coming to an interest rate environment when taking a fixed rate or a hybrid mortgage (50/50) may actually be cheaper than staying in a variable rate. Why you ask…..let’s look at the facts as to why this maybe a good time to take a fixed rate or hybrid mortgage.
1. 5 year fixed rates are at the lowest levels in history, we have never been this low…..3.39% and 3.49% 5 year fixed rates are available through many lenders.
2. The gap between a prime – .50% (2.50%) and 5 year fixed rate (3.49%) is 0.99% and (in some cases even lower ), this is down significantly from 3 to 4 months ago when the gap between a 5 year ARM and 5 year fixed rate was as high as 2.00%
3. We have just seen major Bank’s increase ARM rates by 20 bps as liquidity costs and funding costs are starting to take their toll and forcing the increase in ARM rates, thus making the ARM to Fixed rate spread or gap even narrower and will this trend continue
4. You can’t predict when to time a conversion from ARM to Fixed rate, especially in a volatile market. Fixed rates have a tendency to move ahead of variable rates….when variable rates begin to rise the fixed rate has already gone up and if you convert you maybe converting at a much higher fixed rate than today’s rates.
5. Watch for what I refer to as the “Fixed Rate Bubble”. We have seen a large amount of mortgages over the last two years take a variable rate versus fixed rate, including renewal clients. I estimate that as much as $350 billion in mortgages outstanding are in variable rate today. Probably the highest levels we have seen in the Canadian mortgage market. If we see a large increase or numerous simultaneous increases in prime rate over a short period of time AND we experience a mass conversion from variable rate to fixed rate, what will happen to fixed rates? If demand for fixed rate outstrips supply of fixed rate funding, then fixed rates will have nowhere to go but up. We have seen mass conversions in the past, however, the potential magnitude in volume that exists today has never been experienced before and we could be entering into new territory.
No position is complete without looking at the counter arguments’, in other words why a client should consider a variable rate versus fixed rate mortgage. Once again let’s look at the facts.
1. Bank of Canada has indicated it is not looking at raising the overnight anytime soon or at least will hold off until such time as it sees the economy improving
2. There is no indication that inflation is increasing, therefore supports point 1 above.
3. U.S. has no plans to increase rates for the next two years making it more difficult for Canada to raise rates unless the Canadian economy is growing in spite of the U.S. being sluggish
4. Canada is becoming a safe haven for investors’ thus larger demand for Canadian bonds. This demand is keeping bond yields down thus lower fixed rates on mortgages.
Both positions have merit and no one has a crystal ball and if we did we wouldn’t be working we would be sunning ourselves on an island paradise we just purchased with the massive amount of money we made playing the markets…….well back to reality.
If we continue to see the gap between fixed rate and ARM rates shrink then the risks of taking a variable rate versus fixed rate increases substantially. The risk being that ARM rates could increase higher than 1 % over the next 18 months to 24 months, therefore over the course of a 5 year term the fixed rate may be less costly than the ARM rate. Once the gap between ARM and fixed gets to 1% or less, I believe the smart money would go to fixed rate versus ARM. If the gap between ARM rate and fixed rate is between 1% and 1.50% then a 50/50 mortgage maybe the best bet. If the gap between ARM and fixed rate is in the 1.50% to 2.00% range then ARM rate maybe the way to go. Based on the present volatile market conditions it is hard to predict or say what will happen.
Information provided by Mandy Szucs, TeamSzucs@RMABroker.ca