Why you should lock in your mortgage
By Garry Marr
Published on March 29, 2013 by financialpost.com
Locking in your mortgage is almost like buying an insurance policy — it’s going to cost you money but will help you sleep at night.
There’s little doubt you can do better with a variable-rate mortgage, tied to prime, than fixing your rate for five years or even 10 years, but the gains you make are so minimal it’s almost not worth the risk these days.
They can’t go lower, can they? And what if mortgage rates start to climb? Could that be the last straw for the housing market?
It’s tough to make a pan-Canadian call on where real estate will land in 2013. The Prairie provinces seemed posed to avoid the downturn, but sales are starting to fall in many markets with a price dip happening already or predicted to be on the horizon.
It’s not that hard to get a five-year fixed-rate mortgage for around 3% today with a little bit of negotiating. By comparison, a floating-rate mortgage will at best generate maybe 40 basis points off of the prime lending rate of 3%, a 2.6% rate. And with that rate comes the risk the Bank of Canada will finally get around to raising its key lending rate, an increase your bank will pass along to you.
The Canadian Association of Accredited Mortgage Professionals found that in 2012, 79% of new mortgages were for a locked-in product, 10% for variable and 11% a combination of the two.
“To know your rate [on your mortgage] will be flat for five years, that’s cheap insurance,” said Will Dunning, chief economist with CAAMP.
Real estate author Don Campbell said investors he deals with are trying to lock in as long as they can because rates are so low.
“They want eight or 10-year money because the rates are so ridiculous,” said Mr. Campbell, adding you really want to nail down your costs on any investment. “Besides, the majority of long-term products give you a refinance option in the contract.”
One of the advantages of going longer than five years is under Canadian law the most your penalty can be is three months interest instead of the more costly interest rate differential penalty, which is based on the rate on your contract versus the posted rate.
These days, with rates thought to be at the bottom of the cycle, the banks are not too worried about consumers breaking long-term contracts for a lower rate.
“They could go down even more but do you really care that much if they go down and you are at 4% for a decade,” said Mr. Campbell, adding it is taking a key variable out of any investment equation.
He has harsh words for people going variable trying to make their investment in some Canadian condo markets cash flow positive.
“You are adding a major level of risk. If half an interest rate point makes the difference for you, that is just not a good investment,” said Mr. Campbell.
He says individual homeowners who knows hey are going to be in the same house for a long period of time should lock in costs for the very same reason. “It’s not the cash flow, but [locking in] you know the costs and the lifestyle you can afford,” said Mr. Campbell.
There is a point where the gap between a variable and the locked-in rate becomes wide enough, locking in becomes an expensive proposition. At one point variable rates were almost 90 points below the prime rate at the time, about 2.1% and five-year locked-in money was closer to 4%.
You can always diversify your debt, take half of it short term and half of it long term, but Canadians have not embraced the concept as the CAAMP survey revealed.