Another Debate on Variable vs. Fixed Mortgages

Jeff Evans

In this article in the Financial Post, the age old debate of variable rate mortgages vs. fixed rate mortgages is raised…yet again. It infers that people are in over their heads with variable rate mortgages and that most people are best getting into a fixed rated mortgage.

With the mortgage lending rule changes of April in effect, many people will not have a lot of choice and will have to choose a fixed rates in order to get the most available house for themselves under a high ratio mortgage. However, for those who do have a choice, I would consider this article poor advice and inaccurate.

First of all, variable rate mortgages did not help people get more house than they could afford, as this article infers. The reason for this is that borrowers have to be qualified at a higher interest rate than the variable rate that they received…even before the April mortgage rule changes.

Secondly, if the overnight benchmark rate for the Bank of Canada DOES rise to 4% (a big if that is quite distant in the future, in my opinion), then the prime rate would be 6%, and then you would apply the discount to prime that the variable rate mortgage offers. Right now, I have a variable rate mortgage discount as high as -.75%, which would put the mortgage at that time at 5.25%, not 6%.

Further, the spreads on bonds (the bond market largely dictates what fixed rates will be) are much larger now than they have been in a while. What this means is that bond rates are low, which means a lower cost of funds for the banks, and the spread is their profit margin. Right now, the mortgage lenders are giving themselves an extra .5% margin beyond what they typically do. In other words, if they are pricing fixed rate mortgages 0.5% higher than they currently do, and pocketing the difference. Word is that they are doing this due to “uncertainty” in the markets and don’t want to leave themselves short.

However, however you slice it, they are currently making about 30% more money on fixed rate mortgages now than they normally do…and then is it that much of a coincidence that the newspaper comes out with an article designed to scare people into preferring fixed rate mortgages?

At the same time, albeit I am not a senior economist of a big bank…I still take issue with the idea that the Bank of Canada prime rate will increase significantly in the short term (not that .5% is not significant, but it isn’t as significant as 4%) I still hold the belief that the “economic recovery” in Canada cannot be complete without an economic recovery in the US. I still hold the belief that Canada’s prime rate can only go so far without the US increasing their federal reserve rate. To think otherwise is to look at the Canadian economy in a vacuum, ignoring the relationship between this country and its largest trading partner.

Regardless of whether I am right or wrong about the indications on interest rates on variable rate mortgages, it cannot be ignored that based on todays best variable rates, it would take another 8 interest rate increases of .25% in order for the variable rate to match todays best 5 year fixed rate. If the Bank of Canada decided to raise rates by .25% every single decision date from now on, it would take them almost a year to do so.

It seems to me that we live in a very turbulent world at this time, particularly with US subprime crisises and oil leaks. The wars don’t appear to be coming to an end very quickly either. Can it be safely assumed that we have seen the end of the turmoil? Can they really increase rates to pre-recession rates with such uncertainty and turmoil in the world?

Newspapers are notorious for misquoting, taking things out of context, and manipulating the emotions of the population to meet an agenda of a given party. Do not make decisions based on fear.

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