Host of new choices lure buyers
Many mortgage options
Ray Turchansky, CanWest News Service
Traditional thinking has been that young or first-time home buyers should go with a long-term fixed rate mortgage, while seasoned homeowners opt for a variable rate mortgage. But that thinking has been clouded of late.
More than five years ago, Toronto’s York University finance professor Moshe Milevsky did a study of five-year rolling interest rates during the previous 50 years. It showed that 88.6% of the time, homeowners would have saved money having floating rate mortgages, which are tied to the rise and fall of bond yields, rather than fixed-rate mortgages, which are usually locked in over a period of one to five years. The average saving was $22,000 on a $100,000 mortgage paid out over 15 years.
“At that time, the bulk of mortgages in Canada were fixed-rate mortgages, yet the research showed you were probably better off with floating-rate mortgages in the long run,” Mr. Milevsky says. “That was when the yield curve was upwards sloping, so the insurance premium for going fixed was pretty steep– you were really paying a premium to lock it in.”
Today’s flat bond yield curve, which means paying only 0.5% to 1% extra to lock in a rate long-term, makes fixed mortgage rates more attractive than five years ago.
“I’d be inclined to go with a fixed-rate mortgage, and I would probably push it out further instead of shorter,” says Kate Warne, Canadian market strategist with Edward Jones.
Not all experts agree, however. “I think going variable has been the best approach over the past 10 years, and will continue to be the best approach over the next 10 years,” said Benjamin Tal, senior economist with CIBC World Markets. “If you have had a variable rate since 2001, you have saved many thousands of dollars. I think for the next five years you will continue to benefit from a variable rate, but the difference will not be as significant.”
Apparently Canadians aren’t huge risk takers. “Variable rates in Australia and the U.K. make up about three-quarters of all mortgages,” says RBC Financial Group chief economist Craig Wright. “In the U.S. and Canada, we tend to be more risk-adverse and we tend to have fixed mortgages (30% and 25% in variable rate mortgages respectively).”
But Canadians are being tempted by a host of new mortgage products, including 40-year, interest-only, no-down-payment and subprime mortgages that entice people with poor credit ratings into the housing market.
“Paying off loans slowly, especially non-deductible ones, is one of the biggest impediments to accumulating the retirement nest egg,” says Vancouver financial advisor Adrian Mastracci.
Keys to reducing interest payments are the amortization period, namely the time over which you pay off the loan, plus the frequency of payments and pre-payment options.
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