This money-saving mortgage is on sale right now, but you should take a pass

THINKING OUTSIDE THE BOX:  Fixed or Variable?  That is the question…

The all-star mortgage choice for saving money over the past few decades is finally back on sale at your mortgage broker, bank or credit union.

As was the case before the financial crisis terrorized the world, you can now get a variable-rate mortgage with a discount of close to a full percentage point off your lender’s prime rate. The prime today is generally 3.2 per cent. A variable-rate mortgage at 2.3 to 2.4 per cent is attainable.

In the years when interest rates were low with a bias toward declines rather than increases, variable-rate mortgages were a homeowner’s best friend. Borrowing costs were lower than they were for fixed-rate mortgages, and you benefited from lower costs when the prime rate was lowered.

Today’s interest-rate forecast calls for steady to rising rates – that’s one reason to be cautious with variable-rate mortgages. Another is that the pricing advantage they offer over fixed-rate mortgages is comparatively weak. So while variable-rate mortgages are on sale today, they’re not very attractive. You’re probably better off with a fixed-rate mortgage.

The financial crisis started about 10 years ago and reached peak scariness in the fall of 2008 through winter 2009. One of the legacies of this period is a markedly higher level of predatory behaviour by banks toward their customers.

Canada’s big banks withstood the crisis better than many global counterparts, but they were still bruised and rattled. To shore up their revenue and profit growth in an uncertain world, they became more aggressive about raising fees and rates for clients.

One measure that stood out was the near-elimination of discounting on variable-rate mortgages. “Discounts on variable-rate mortgages went from 1 per cent or more off prime all the way to zero, or even prime plus, then back down to the deeply discounted levels we’re seeing for certain mortgages right now,” said mortgage broker David Larock.

Right now, big, low discounts on variable-rate mortgages don’t apply in every case. That’s another gift of the financial crisis – more complexity for buyers of financial products. Mr. Larock says you get the biggest discount on variable-rate mortgages when you make a down payment of less than 20 per cent when buying a house. This is because you’ll have to buy mortgage-default insurance, which protects your lender against you not making your payments.

If you make a down payment of 20 per cent or more and buy a house valued at less than $1-million, Mr. Larock said your discount on a variable-rate mortgage would be in the area of 0.70 per cent. The lower discount reflects the fact that your lender pays the cost of default insurance instead of you.

No mortgage-default insurance is available on homes valued at $1-million or more, which makes lenders stingier with discounts. Mr. Larock says buyers in this group should expect a discount on variable-rate mortgages of about 0.5 per cent.

Eight in 10 of Mr. Larock’s clients are choosing fixed-rate mortgages today, with the rest choosing a variable rate. The reason for the heavy skew to fixed rates can be explained by the unusually modest savings you’d get with a variable rate over a fixed rate.

Five-year fixed-rate mortgages can be had with rates in the 2.7 to 3 per cent range, while a five-year variable-rate mortgage might go for 2.3 per cent if a client had a down payment of less than 20 per cent. “What I say to borrowers is that you’re not being paid a whole lot to take on variable-rate risk,” Mr. Larock said. “You’ve basically got two [quarter-point] increases by the Bank of Canada before you’re going to end up paying more for your variable than for your fixed rate.”

One more demerit for variable-rate mortgages: Lenders have recently shown a pattern of increasing their prime rate in step with the Bank of Canada’s own moves on rates, but not passing along the full amount of rate reductions. Remember, the prime is used to set borrowing costs on variable-rate mortgages.

If interest rates were to remain steady at current levels, you’d typically pay a bit over half a point more if you went with a fixed versus variable rate today. Mr. Larock suggest you view this rate premium as the cost of insurance against the possibility of rising rates in the years ahead. Ten years after the beginnings of the financial crises, this does seem a legitimate risk.

Rob Carrick      The Globe and Mail      October 11, 2017

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