Under normal circumstances, the choice between fixed and variable-rate mortgages comes down to a simple question. Given that the fixed-rate option is going to cost more over time, how much extra are you prepared to pay for the security that comes with knowing exactly what your mortgage payments will be? For some, paying that premium makes sense. Not all young homeowners, for example, are in a position to take on the risk that comes with fluctuating mortgage payments.
But our circumstances are far from normal. Strong demand for Canadian bank bonds on global markets is making it cheaper for them to access funds. That’s allowing them to ratchet their fixed mortgage rates down. Earlier this month, the Bank of Montreal announced a five-year fixed-rate of 2.99%. That set a Canadian record. According to ratehub.ca, ING Direct is offering a 10-year fixed at 3.99% (on the date of this posting).
Meanwhile, variable rates are less attractive. I spoke with Peter Majthenyi of Mortgage Architects in Toronto on Friday. “The typical discount [on variable-rate mortgages] has been prime minus 0.75%,” he told me. You won’t find that kind of a deal from a bank on ratehub.ca today. The best rate for a five-year variable is prime minus 0.5%. For a three-year variable, it’s prime plus 0.7%.
“They’ve taken all the discounting away,” said Majthenyi. “Therefore I’m recommending that people stay away from variable.”
Majthenyi told me the banks have done this in virtual lockstep. And he’s seen it before, after the credit crisis hit in 2008. “All the rates just spiked,” he said. “We all knew it wasn’t sustainable. The variable went to prime plus one – crazy. Sure enough it came all the way back down to prime minus .8% over the course of a year and a half.”
Meantime, Majthenyi is recommending his clients look at a one-year open rate, just to see how things progress, or lock in with a 10-year fixed.
He does not recommend a five-year fixed mortgage. They don’t provide a long enough fixed period to justify the premium. “I get nervous about fixed mortgages,” he said. “Not so much the 10-year, but a five-year because if anything crazy does happen two or three years from now, I’m insulated for a bit. But what’s going to happen at my renewal? What am I going to pay in years six, seven and so on?”
Does all of this mean you should renew your mortgage? It’s a good idea to compare your deal to competitive offerings once a year. But there is a lot to consider before refinancing. Do you have other debts you need to consolidate? Is that the right thing to do, given the charges involved? How important is a low monthly payment to you? Every situation is unique.
As for new home buyers, don’t be tricked by the current low rates. The Bank of Canada may hold rates low in the short term, but not forever. There are a couple of standard measures to help you decide how much you can afford. The Canada Mortgage and Housing Corporation recommends that you not spend more than 32% of your monthly gross income on housing costs. If you’re at your limit with rates this low, you’re probably looking at too much house. Majthenyi offers clients another useful guide: don’t borrow more than about 4.5-times your gross household income. Even for young, high-income earners, a mortgage above that level may be unwise.