Wow, the Bank of Canada has gone and dropped the prime lending rates to banks by another 50 basis points earlier this week and the major banks jumped right in after them and most have announced their prime rate is now down to 2.5% If you went with a variable rate mortgage a year ago or earlier, as I advised people too, you are now probably paying less than 2% interest on your mortgage payments. How does that feel?
To put it in perspective if you had locked in at 5.5% a year ago, and your mortgage was only $250,000, you would be paying almost $500 more a month than if you had a variable rate at prime -.5. For a rental property in a market with more vacancies appearing this is huge. That allows you a $500 window of price reductions for rent if you need it, or a one month subsidy to attract renters. If the mortgage was on your primary residence you have managed to reduce expenses without cutting back! So it is also a winner.
So a few new questions that popped up now. First, with the prime rate so low, should you lock your variable rate mortgage in before it goes up? Second, are variable rate mortgages still the best way to go if I need a new mortgage?
With all the dismal results pouring in the Finance Minister is now stating that this recession could drag on for quite a while. Translation is that the government cannot afford to raise interest rates until they see a definite turnaround in the economy. This should keep rates low for possibly the entire year and would indicate to leave your variable rate mortgage where it is.
At this point banks are no longer offering prime minus anything on their mortgages or credit lines. Everything has switched over to prime plus a percentage. Rumor from the mortgage people and banking industry is that this will change near the end of the year and we may see prime minus a half percent again in 2010. At this point there are some very attractive one year rates out there that may be a better option. Then next year you can convert them to variable, depending on where the rates are trending and the overall economic situation.
If you have any questions or comments, I would love to hear them.
Good Day. I have just locked in for 5 years at 4.09.
I did this because I am risk averse but mainly feel anxiety when considering matters such as what to do with investments, etc. So, I don’t like the idea of thinking about the mortgage all of the time, watching interest rates.
Anyway, I cannot find information that I understand regarding the options. So, I could not jump into a variable mortgage.
If, under present conditions, I took a fixed variable mortgage, which I understand to mean gives me the most options but a 0.3% penaltycompared to an open variable, I could have an interest rate of about 3.3%
My payment would be set at the beginning based on the amortization in effect and that rate. When rates fluctuated, the payment would remain the same but the amount of interest accrued for the month (based on monthly payments) would fluctuate. A rise in interest rate would mean a reduction in the amount of principal paid from a payment. And if rates fell, the opposite would be true.
If rates jumped so that the interest accrued for the month was greater than the payment, I can only assume that an increased payment would be required but perhaps the mortgage principal would actually rise.
Assuming all of the foregoing to be correct, I am left with wondering what would occur if a person had a variable rate mortgage, fixed, and wanted to lock in.
Under today’s circumstances, the terms of the mortgage would be Bank Prime plus perhaps 0.5% (I have an understanding that these terms change over time and that there are people holding mortgages having terms of Bank Prime minus 0.5%).
The rate would, as above, be perhaps 3.3%.
If that person wanted to lock in now, what would they be offered? Would they be offered the same rates as people opening fixed rate mortgages for various terms? With the fixed variable, there would be a period of time remaining on that term. Assuming they were to be offered a range of rates based on those offered to people opening new fixed rate mortgages, would they be able to choose any term, a term longer than what is left on their own existing fixed variable term or perhaps a term equivalent to the original term period chosen when the fixed variable mortgage was taken out?
If the variable rate mortgage holder were offered better rates than a person opening a new fixed rate mortgage, the only drawback to opening a variable would be the possibility of not locking in quickly enough to obtain a rate at least as good as the going fixed mortgage rates.
In the recent past, the rate spread between fixed and variable rates was relatively great, I think. At that time, it seems like a no brainer with little risk.
If the variable rate mortgage holder were offered the same rates as being offered to a personn opening a new fixed rate mortgage, then it would be unlikely that variable rate holder could lock in at the lowest point and would end up paying a bit more than the best rates that became available.
And, if things were particularily unsettled, the very time locking in might become attractive, the would be substantial risk of not being able to lock into a rate anything like what was available at the bottom of the trends.
So, I am mainly asking about the rates and other circumstances when locking in a variable mortgage.
If you’ve read this far, thanks for your attention. I hope my writing is clear.
Regards, Tim.
Hi Tim,
Thanks for the comment and by the small novel you posted you have a few questions you obviously have thought about. So let me take a run at answering them, if I miss anything or you need clarification let me know. I will start with some additional background.
4.09 is actually a great rate, so good job there, if you are risk adverse it is a wonderful solution. Currently most of the variable rate mortgage out there are sitting at prime plus .5% or more so the gap between what you have and the variable you could have had is only about 1% which makes a small difference in interest paid over the term of the loan.
We have several mortgage from a year ago or longer that we were able to secure a rate of prime minus .5% all the way up to prime minus .8%. Those mortgages at this time are sitting at 2% or less which is a 2% difference and adds up slightly more. They are rental properties (except for our home, which is a prime minus -.8% as well), and it does improve cash flow for us which is a prime concern for a landlord right now as economic times are tougher.
With a variable rate mortgage as rates lower most banks will automatically lower the payments, some however will not adjust the payments and simply apply more of the original payment to the principal (if this is the way your bank works, confirm it is going to principal, and not paying the interest portion down early!!). Also with some banks you can lock in your payment amount so you are paying a bit extra each month, then if rates do move up a bit your payment isn’t affected.
An example would be a payment amount of say $1237 per month. You could make a fixed payment of usually up to 5 or 10% each month on the mortgage (depending on the financial institution) payments so you pay a flat $1,300. The additional going towards your principal again. If rates do drop they may ask you to lower your payment, but they may not too!
As a home owner with a goal of paying your mortgage off this works in to ways, total interest paid out is reduced and by reducing the principal, even by just a bit each month, it starts to shave time off the total mortgage amortization period.
If you saw rates start to rise and you decided to lock in your variable rate you are generally limited to the banks posted rates, with possibly a small additional percentage penalty as well. Banks are pretty flexible with posted rates if you ask, so there is nothing in stone and depending on your negotiating skills this could be reduced. The term of the mortgage would just be the remainder of the term left on the original mortgage.
Now with the current economic situation it will possibly be a year or longer before Canada as a whole comes out of the recessionary period. The government during this time is highly unlikely to raise rates during this time period as it could grind any growth to a halt. So while we are in the doldrums the variable rate holders should look at holding on. As the economy starts to improve, that is when they should be watching what is happening with rates, although they will slowly increase initially anyways so as to not derail any economic growth.
If we look back historically variable rate mortgages always came out ahead to homeowners for amount of total interest paid. With our current situation of never before seen low rates, the amount of difference may be lessened making the risk of going variable slightly higher than it eve has been. In addition with current variable rates at prime plus a portion of a percent, the difference is lessened even more.
The great leveling factor for mortgages is time, and with a 25 year mortgage variable should work out to be less than a fixed rate. There will be certain periods where it backfires (during rising interest rates), but during flat or times of reduced rates the variable comes out a head.
One other factor that affects this is people don’t live in the same home for 25 years as commonly as they used to. It is now much more common for people to live in a home for ten years and then upgrade as values increase, space issues come up or needs change. So some people have mortgages even longer now due to starting over every ten years or so.
I hope I answered your questions, I hope I added enough additional information to help you . If there is still something you would like clarified let me know. I am not a mortgage broker or a banker, and not all mortgages and banks are the same, so there will be exceptions to everything out there, these are just the various events we have seen, noted and been updated on by our various brokers and business contacts.
Best of luck and I hope you enjoyed the article.
Nice site! Thanks for the great post
Hi, We have a prime -0.50% mortgage which comes due in 2013. We’ve significantly paid down the principal with additional weekly payments and with the difference in the initial mortage rate of 4.25% and the current rate of 1.75%. It seems to me that we should keep it until rates are reviewed sometime next year and perhaps until 2013. What are your thoughts?
Thanks,
Brent in Calgary
Hi Brent,
I’m not an accountant, or a mortgage broker, I don’t have a crystal ball and I cannot see the future, so any thoughts I provide here need to be evaluated by you and not just accepted as the only solution. There is my forewarning.
There is no definitive answer for anyone as each person’s risk tolerance, and understanding of the process is slightly different, but it appears you have made some wise decisions already by making additional payments. This puts you in a position where you have more leeway than someone who has sat idly by. If rates do increase drastically, which I don’t suspect they will, you would still be OK by refinancing your lower principal at a full 25 year term or longer. Not an ideal situation, but at least a backup for you. This can take a tremendous burden of pressure off and make any decision you make now less risky.
With a -.5 current rate and interest rates staying where they are now until potentially the new year at this point I think it may be jumping the gun to lock in at a higher rate currently. If they do jump at the next rate announcement date it will be a gradual jump, not huge two or three percent leaps which still gives you additional time to lock if things look bleak for future low rates.
In the big picture with a prime -.5 mortgage, bank prime rates have to increase to 4.5% before you are in a losing scenario and that may take more than a year or two to achieve. Based on you being able to lock in at 4.0% currently that is. By 2012, rates may be up there, but by then you would have gained two years plus of still making extra payments, paying a lower amount and getting that principal reduced putting you in a very favorable position! Does that sound realistic to you?