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moneysense.ca, 31/01/08
This and That
- How did a junior-level trader with a major French bank manage to bet 50 billion Euros of the bank’s money on stock futures?
- If you are renewing your mortgage, Rob Carrick feels that variable-rate might be the better option now.
- It is shocking to read the sleazy tactics employed by the door-to-door salespeople selling fixed-price natural gas or electricity contracts in Ellen Roseman’s column and blog post.
- James Daw writes in The Star that the current bargain gas price of 24.5 cents per cubic metre charged by Enbridge may not last.
- Money manager Leith Wheeler explains why they are bullish on natural gas.
Blog Round up will return next week. Have a nice weekend everyone!
moneysense.ca, 31/01/08
Variable rate mortgages might be in a good position now, but they still aren’t for everyone. The problem is that the variable rate will be most useful to people who can barely afford the current level of prices because they think the rate will go down; but if it goes up they lose their home. They’re most appropriate for people who can easily afford a fixed-rate mortgage but want to save a bit of money.
I kind of disagree, historically (See link), the average rate of a mortgage since 1951 is around 9%. I did that by simply taking an average of each years rate on that chart, and then take the average of those yearly averages. Probably not exact, but close enough for my purpose.
So, if historically the average mortgage price is 9%, then I would think if variable rates usually end up being cheaper if you add in about a 2% buffer then my thinking would go to something like ‘if you can lock in for 25 years under 7% you will probably be better off in the end’ . . .
Proof, maybe not. Will it work out all the time? Possibly not. I just think most people when talking about their home don’t really need to hear when two years from now there is an emergency and the BoC decides to hike the rate 1.25% in 8 days and their payment jumps from 1160 to 1300 or so. Of course, if you were budgeting to pay 1350 a month anyway and have been putting the extra 190 a month in to some saving account called your ‘Just in case interest rates go WAY up’ account then you’ll be fine. . . but honestly, how many people really do stuff like that with an extra 190 bucks a month? They would probably have just bought an SUV instead of a Kia Rio 5 or something instead.
Whoops, forgot linke . . .
http://bankofcanada.ca/pdf/annual_page52_page53.pdf
I can’t recall which personal finance reference I saw it in, but statistics have shown that around 75% of people with locked-in mortgage rates underperform those with variable rate mortgages. It makes sense, since banks have professionals who calculate this kind of stuff to ensure that they don’t lose money. I’ve always had variable rate mortgages. I’ve only tried a fixed rate natural gas supplier once and lost money, so I’m on variable rate on that, too!
Yes, but to use you’re point against the variable rate side that the banks are calculating how they can make the most money. That’s exactly why when rates are getting lower and will, in most estimates, be higher in the future they advertise variable rates. That is because the powers that be are looking at every single way to squeeze as much out of the populace as they can.
I’d also really like to see some stats on default rates for variable, and each fixed term length mortgage. For example what’s the default rate on Variables vs fixed 1 year, fixed 5 year, fixed 10 year and fixed 25 year mortgages. It would make for some interesting reading. I wonder if that data changes when you have periods like 2003 and ‘04 where rates were historically low and then increased in to 2006, 07, and now ‘08.
Anyone know where I could find stats like that?
Trac – the big problem with how you worked out the averages is that you can’t lock in a rate for 25 years. As far as I know, the longest any place will lock in a fixed rate is 5 years. That being the case, you would want to compare 5 year spans (ie, the average of 1990-1995, 1991-1996, 1992-1997, etc..) and see what the average of those is.
Of course, that doesn’t take into consideration that a variable rate can be turned into a fixed rate at any time… let’s say 9% was the average, variable right now was 5%, and the bank would offer you a fixed rate equal to 2% higher than the variable rate. At that point, you could stay variable until interest rates rose to 7%, at which point you could flip to fixed at 9% and still be ahead overall.
What, where in the world can you not lock in for 25 years? 5 years the max, heck no. Right on ING Directs web site they list 10 year fixed, and I bet if you call and say what you want they would do 25 for you.
http://www.ingdirect.ca/en/mortgages/index.html
Also, canequity.com lists their available 25 year fixed rate. Maybe your bank told you this to talk you in to something you didn’t want because rates are low, I would say next mortgage you are doing, get a broker.
P.S. The average of all the 5 year rolling periods from 1951 – 2007 is 9.3%.
Also, the spread of Variable to fixed is only around 0.65% right now. So in your example above of variable was 5% then the 5 year fixed would be around 5.65%. If rates were to go up 2% over a 2 year period then the fixed guy makes out like a bandit. Variables only work out if people lock in and rates go down for an extended period of time afterward.
All I’m saying is that at some point when rates are really low (like 2003/2004) there is a much greater chance of the rates going up rather than down more. At that point banks seemingly advertise variable rates as the way to save the most cash. I argue that they are out for profits and locking in under 7% is probably the best strategy.
Currently the 25 year fixed rate is around 6.95, so for right now I think it’s a really tough call. If that gets below 6% then I would think the best thing to do is just lock it in and relax in your home for 25 years knowing you’re smooth sailing the whole way. Will it work out all the time? Absolutely not. I think the peace of mind is worth that risk far more than the amount of cash the variable rate has of potentially saving.
Make sure you can pre-pay and increase payments to reduce your amortization period during this time, don’t lock in to 25 years with no options
We are on a five year and the only reason for that is because we felt that our budget was too tight and we couldn’t afford an increase in mortgage payments (or the stress of worrying about it).
I personally think the difference between short and long term mortgage is almost negligible in the long run so I’m not too worried about it.
I think most first time home buyers who are stretching to buy a house should be locking in for at least a few years in order to buy some time to pay the mortgage down before the mortgage comes due.
Trac – I know ING won’t do 25 year locked in rates, and the big banks definately won’t, but interesting to see that canequity shows them… I’m in Ontario, so perhaps it’s not available, or only newly available here. If it is available, I know a few people who might be interested as they go to buy their first home, so I’ll have to direct them to that site. Thanks!
And interesting on the 5 year rolling periods, I would have expected it to be different considering the 80’s with the 15%+ periods, and the early 00’s with the single digit rates. Then again, averages probably work out the same, we’d probably have to get technical and look at the deviations to try and come up with a perfect answer (don’t worry, I’m not suggesting we do it!).
You make a great point about when banks heavily advertise variable rates… I had never thought about it until you mentioned it, but once I did I realized you were dead on. I also agree completely about making sure you can make extra payments whenever you want, not getting stuck on an amortization period.
I’m in year three of a ten-year fixed term at 5.0%, our first and hopefully last term of financing on this home based on regularly increasing payments. At the time, as well as today, I thought it improbable that we could do better at variable over that term. While I agree that variable has it’s time and place, I think longer-term fixed was the way to go a few years ago. Although arguably it is a form of “market-timing” and we know where that gets you.
A wrinkle to be thrown in when considering the nature of rates for the past 30, 40 , 50 years or whatever, is that the monetary policy of the BoC was changed in 1992(?) to adopt an inflation target rate control directive to try to hold inlfation at 1-3% if I’m not mistaken.
Interest rates since then therefore would have different influencing factors than before – and much of the data that skews the long term rate histories higher occurred before 1992.
Just food for thought…
If the only criterion is saving money, variable-rate mortgages are definitely the way to go. According to Prof. Moshe Milevsky, variable-rate would have saved money over fixed-rate 88% of the time. Link
Our first mortgage was a 5-year, fixed-rate mortgage at a little bit over 5%. Over the five years of the mortgage, the variable rate never exceeded the fixed rate we were paying. Often times, the variable rate was 1% to 2% cheaper over an entire year.
Hi CC. Wow, his study found the statistic to be 88%? I knew it was well over 50%, but 88% is totally crazy. I’m pretty sure I have a personal finance book at home that said it was around 75%, but I think that book may be more than a decade old…
For me, I’ve only bought townhouses or condos which were the size that I “need” and nothing more. That allowed me in to completely pay off my mortgage in 3 yrs (in both cases). Also, having a small condo or townhouse has always generally kept my property taxes and heating bills to a minimum as well, which left me more money to pour into investments! =0)