Variable mortgages merit closer look amid signs of dropping interest rates
CALGARY (CP) - With enough mortgage choices out there to make your head spin and fresh signs that interest rates could be dropping, a good place to broach the subject of home financing is the age-old debate of fixed-term versus floating rates.
While fixed terms appeal to those with tight budgets who prefer knowing exactly what the month-to-month payments are, a good argument can be made to go with a floating or variable rate mortgage - at least for the short term.
Andrew Moor, president and CEO of Invis, one of Canada's biggest mortgage brokerage firms, said his company is currently advising people to go with a variable rate mortgage and then maybe lock in once rates come down.
Moor said a "strange anomaly" is occurring now where larger-than-normal spreads between fixed-rate mortgages and bond rates - which compete against each other for investment dollars - suggest that mortgage rates are likely to drop over the next several weeks.
As a graphic illustration of this, Toronto-based Royal Bank (TSX:RY) cut its long-term mortgage rates twice in one week in late September.
Added to this is a growing belief that a looming economic slowdown will force the Bank of Canada to keep its key lending rate unchanged at 4.25 per cent for the next few months and potentially even lower next year.
Earlier in September, the central bank signalled that a quicker-than-expected slowdown in the U.S. housing market could bring about larger economic problems that would require rate decreases on both sides of the border.
"It certainly seems to us that there's very little risk of the variable rate mortgages going up in cost over the next little while," said Moor.
"So if you close on a variable (mortgage) today, you can expect your monthly payments or your interest costs are going to drop for the next little while."
Invis says that even with seven rate increases over the past year, people who had variable mortgages still fared about as well as those who had locked into a five-year fixed term.
Still, picking between a fixed and floating rate mortgage should be about more than just simple number crunching, said Nancy Mitchell, senior manager of RBC's home equity financing group in Toronto.
"The whole thing around choosing mortgages is not only about the rate and what you're going to pay, but it's a great time to look at your overall needs."
This includes what your future borrowing needs might be like - if you have kids going to university or want to undertake a big renovation.
It's also about comfort levels.
A first-time home buyer already frazzled with getting a big mortgage might not want the extra stress of seeing their payments increase if interest rates rise slightly.
"That same person when they come up for renewal, they've had the experience of owning a home for a few years. They know what their expenses are and their comfort level is there," said Mitchell
"It may be very appropriate at that time for them to look at a floating rate."
One potential strategy is to get a variable-rate mortgage, but set the payments at or slightly higher than those required for a five-year fixed term. That way, if rates go up you're more than covered. And if they don't, then you're simply paying the principle down faster.
Most financial institutions also now offer the ability to hedge your bets and split your mortgage into two pieces - one that you lock in and one that you allow to float.
Before you get a mortgage, it's important to set goals and clearly know your present financial status and cashflow, says Kevin Gebert, a certified financial planner with Partners in Planning based in Surrey, B.C.
Gebert likes fixed-term mortgages because it allows people to fix their costs, set up a budget and set goals throughout the year to make extra payments that will take down the mortgage faster.
"What's really scary is someone doing a variable rate mortgage, where they're penny pinching and going into debt, but all they can afford is that variable rate," he said.
"And then they don't worry about the future."
With the rapid ramp-up in housing prices in most big markets across Canada, new mortgage products have been designed to help people afford the bigger price tags. These include mortgages that have longer terms, like 30 and 35 years.
In late September, First National Financial LP became one of the first lenders in Canada to offer an interest-only mortgage that allows homebuyers to pay only the interest on their property for the first five or ten years.
"Like a lot of things in financial services, you bring innovation that makes sense for a certain consumer, but it can be abused by others," said Moor at Invis.
"You've got to have a plan in place that says 'I'm going to have more income to be able to handle that payment five years from now.' If you're just doing it without any thought as to how to handle those extra payments later on, then it's a fairly foolish thing to be doing."
© The Canadian Press, 2006
