Getting a Mortgage Today? Fixed or Variable Rate?

January 31st, 2008 Categories: First Time Buyers, Mortgages, Economics, Finance

The simple answer to this question is to go variable as more rate cuts by the Bank of Canada are anticipated in the next few months. (See my article last week explaining this.) Remember you can always lock in at a later date.

Just in case you’re new to all this stuff:

The discount rate is the interest rate that a bank is charged to borrow short-term funds directly from the central bank (Bank of Canada).

The prime rate is the interest rate that commercial banks charge their most credit-worthy customers.

Banks in the past would set their variable mortgage rate at 0.9% – 1.0% off prime. Not today. They are narrowing the discount so as to improve their profit margin on variable products.

I read an article in the Financial Post on the weekend which you might find interesting (reprinted below).

BORIS’ READER’S DIGEST VERSION of Financial Post article:

1) The banks are not obligated to lower prime just because the B of C rate has fallen, although most likely they will.

2) With rates falling, the banks will recoup some of their losses by reducing the discount off prime that they give to borrowers.

Mortgage: To fix or to float?

Banks expected to get stingier with discounts

Gary Marr, Financial Post Published: Saturday, January 26, 2008

Would you borrow money from someone if they could change the rate of interest whenever they wanted to?

About 20% of Canadians signing up for new mortgages have been doing just that. One out of every five new mortgages is now a variable rate product tied to prime. Prime is dictated by your bank.

As rates tumbled during this housing cycle, consumers worried about locking into long-term mortgages. The fear of being shut out of the latest rate cut from the Bank of Canada had consumers looking to products with floating interest rates.

Generally, when the central bank cuts rates, your interest rate comes down. But as the global credit crisis has widened, one big question is whether the banks will continue to lower prime with every cut from the country’s central bank.

So far, the answer is a clear yes. The major banks went along with a 25 basis cut from the Bank of Canada this past week and lowered their prime lending rate for customers from 6% to 5.75%.

“The word on the street has been that maybe they wouldn’t drop,” says Don Lawby, chief executive of Century 21 Canada Ltd.

Whether the banks continue to pass on Bank of Canada cuts probably will not change demand for variable rate products, he predicts. One of the reasons he does not think consumers should or will panic is that they always have the option of locking in their rate on a variable rate product.

Most variable rate products sold by the banks include an option that allows you to fix your rate for the remaining term of your mortgage–albeit at a slightly higher rate than you might normally achieve if you did not have a mortgage contract.

“The issue will always be, ‘is the rate I can negotiate for one, two, three or five years better than my current variable rate or not?’ That’s the decision the consumer is going to make. If consumers think rates are going up, they lock in,” says Mr. Lawby.

But the truth is, floating rate mortgages have been rising for months but it has been happening in such a subtle way few people have noticed. A year ago, a consumer could borrow money at 90 basis points off prime. Anybody with that type of deal is now paying 4.85% interest based on the latest cut.

Unfortunately, if you are borrowing today, credit availability has tightened. As the banks’ costs have increased, their profits have narrowed. To deal with the shortfall they cut the discount offered to 50 basis points off prime.

Essentially, they have balked at the Bank of Canada rate cut by cutting the discount. That same variable rate mortgage today will be at 5.25% interest.

Given the shrinking discount and the uncertainty of the banks going along with future rate cuts, does it make sense to continue to have a floating interest rate on your mortgage?

Moshe Milvesky, a professor at York University’s Schulich School of Business, wrote the now widely disseminated study on whether it made sense to lock in your mortgage rate. In the study which looked at decades of interest data, he found consumers did better 88% of the time with a floating rate mortgage.

“It’s the other direction that worries me. If the Bank of Canada lowers rates and they raise prime or the banks arbitrarily raise prime … that’s more worrisome because of unpredictably,” says Mr. Milvesky.

He predicts the banks will probably just get stingier with the discounts they offer rather than not passing along Bank of Canada rate cuts. They can knock the discount down to 10 basis points and few people will get upset, says Mr. Milvesky.

Ultimately, he does not see a sudden rush to fixed rate mortgages but it will open the eyes of consumers. “It makes them aware of the fact that it is the bank that controls their interest rate, not the Bank of Canada,” says Mr. Milvesky.

Tags: Bank+of+Canada+rate, fixed+or+variable+mortgage, discount+rate, prime+rate

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Getting a Mortgage Today? Fixed or Variable Rate?

The simple answer to this question is to go variable as more rate cuts by the Bank of Canada are anticipated in the next few months. (See my article last week explaining this.) Remember you can always lock in at a later date.

Just in case you’re new to all this stuff:

The discount rate is the interest rate that a bank is charged to borrow short-term funds directly from the central bank (Bank of Canada).

The prime rate is the interest rate that commercial banks charge their most credit-worthy customers.

Banks in the past would set their variable mortgage rate at 0.9% – 1.0% off prime. Not today. They are narrowing the discount so as to improve their profit margin on variable products.

I read an article in the Financial Post on the weekend which you might find interesting (reprinted below).

BORIS’ READER’S DIGEST VERSION of Financial Post article:

1) The banks are not obligated to lower prime just because the B of C rate has fallen, although most likely they will.

2) With rates falling, the banks will recoup some of their losses by reducing the discount off prime that they give to borrowers.

Mortgage: To fix or to float?

Mortgage: To fix or to float?

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