John in HomeBuying, Money
With all the news about interest rate cuts recently, many home buyers are wondering if now is the right time to go with a variable rate mortgage. The Globe’s Rob Carrick advises that variable is the way to go right now. There are a couple of reasons why Carrick recommends a variable rate mortgage.
Firstly, short term interest rates are expected to drop this year. The economic slowdown in the US has already led to drastic interest rate cuts south of the border, and the Bank of Canada is expected to continue trimming rates this year. This means that variable rate mortgages, which are tied to the Bank of Canada rate, are also expected to drop.
Another reason variable rate mortgages are more attractive is because banks are charging a lot more for a fixed rate mortgage than they have in the past. In a previous post, I discussed how fixed rate mortgages are typically benchmarked against the yield on five-year Government of Canada (GOC) bonds. The interest rate that banks charge for a five-year mortgage has been on average 2.44% higher than the yield for a five year GOC bond. This means that if GOC bonds were returning 4%, banks would be charging roughly 6.44% as the posted rate for a five-year mortgage.
This spread between the five-year bond rate and five-year mortgage rates has ballooned to almost 3.9%. Part of this increase can be attributed to higher costs of borrowing due to the subprime problems in the US market. But Carrick’s most recent article suggests that at least part of this increase in the rates banks are charging is "to compensate for difficulties elsewhere."
Carrick goes on to outline a “slick” mortgage strategy for borrowers who eventually want a fixed rate mortgage. He suggests taking a variable rate mortgage with a reduced introductory interest rate for the first 6 months to a year, then converting to a fixed mortgage after that. Sounds great in theory, but there may be a hitch in practice. Melanie McLister at Canadian Mortgage Trends has these words of advice for borrowers interested in this strategy:
Make sure your fixed conversion rate is low enough to make it worthwhile. Many big banks, for example, will only let you convert your variable rate into their posted fixed rate minus 1%. With posted rates at 7.39%, that would stick you with an abnormally high rate of roughly 6.39% if you converted today. Today's best non-bank fixed rates are under 5.90%.
John Pasalis is a sales associate at Prudential Properties Plus in Toronto and a founder of Realosophy. Email John
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