Interest Rates on the Move!
We always get a barrage of news reports when rates head up by the slightest amount. Not quite as many Headlines as rates move downward, at least not until politicians start squawking that we are getting ‘too good of a deal’…whatever that could mean. Interestingly enough people tend to shift towards action once rates trend back upward, after 18 months of 2.99% or lower 5 year rates it was bound to happen at some point.
The Short Version
- Prime is not moving, if you are in a discounted variable you should most likely stay there – consult an independent Broker for greater analysis of your own situation.
- Locking in exposes you to far more serious prepayment penalties than you ever have to face in a variable rate mortgage.
- Fixed rates have all inched up about .40% or less. Not a huge move, also not necessarily the ‘end of low rates’ either.
- Even if rate move to 4.5% there will not be blood in the streets, it is not that radical of a payment difference (about $80.00 per month per 100K of mortgage money).
- Be cool, do not take any hasty steps. Consult a Mortgage Expert.
- Skip to the bottom and read ‘In Conclusion’
The Long Version
Let’s be clear that the recent interest rate movements have all been with regard to fixed rate product, not variable rate product.
Prime rate (upon which variable rate mortgages are based) is dictated by the Bank of Canada whereas fixed rates are dictated by the Bond market, because the two forces (the Bank of Canada and the Bond market) are largely unrelated to each other it is possible to have movement in one set of interest rates with no movement in the other, on occasion you can see Prime rate moving in one direction while Fixed interest rates move in the opposite.
Let’s talk about Prime first, nothing has happened here since September of 2010. Prime remains at 3%. It does not appear likely that prime will move anytime soon either, most analysts and economists are suggesting it will be 2015 before we see an uptick in the prime rate. The next opportunity for Prime to move (there are 8 each year) is this coming Wednesday, July 17. Once again it is unlikely in the extreme that prime will move.
Reasons for the bank of Canada to increase prime would be to;
- Strengthen the Canadian Dollar
- Fight Inflation
- Cool the economy
Clearly, no action is required on any of these three fronts.
Canada will likely continue to mirror US policy, as such keeping an eye on the US Fed is always a good idea.
However what we do see is a continued variation in the discounts (or premiums) applied to variable rate mortgages. When you sign on for a variable rate mortgage at a set discount (or premium), said discount (or premium) remains in place for the full term of the variable rate mortgage, typically 60 months. It is when you are up for renewal that the movements in discount and premium matter.
Rewind the clock back to 2008, the offer was Prime -.90%, by the Spring of 2009 we suddenly had Prime+1.00% (a run-up that took place over less than 10 business days). After six months or so the began to drop by 0.10% per month and continued for ~18 months straight taking us to the Spring of 2011 when we were back to offering new variable rate mortgages at Prime -.85%.
However, by the Fall of 2011 variable rate discounts were gone once again.
Over the past two years we have seen an easing to the current offering of Prime -.40%, (net rate of 2.60%) – Variable Rate Mortgages are starting to look much more attractive against current five-year fixed rate offerings of 3.39%.
Where is the (variable rate discount) trend headed next? The wild card in answering that question is the upcoming Federal Budget and the potential impact it may have on the margins currently charged on fixed rate mortgages. It is possible we will see an increase in those margins and thus an increase in fixed rate mortgage rates independent of Bond performance, if this is the case, there will be less pressure on the banks to discount variable rate mortgages from Prime as the spread between variable and fixed will grow too wide for most lenders comfort.
In other words, do not expect a 2.60% net variable rate to be offered if the 5 year fixed rate rises closer to 4% or beyond. Holding out for a deeper discount may not be the prudent strategy at this point. More to follow on this angle as data become available.
What about fixed rates?
Indeed, over the past few weeks this is where the action has been, with every fixed rate product seeing a rate increase;
Current rates
1yr 2.69%
2yr 2.69%
3yr 2.89%
4yr 2.89%
5yr 3.39%
7yr 3.59%
10yr 3.99%
**Rates subject to change without notice**
The driver of the recent rate hikes has been the increased performance, optimism, and decreased margin, within the Bond market.
Let’s take a moment and drill down into what these interest rate hikes really mean to the average mortgage seeker or holder though;
Dollars and sense 101
Using an example of a $100,000 mortgage (to give you an easy metric to apply all of these figures to your own mortgage)
0.10% movement results in,
A net impact on your mortgage payment of ~$5.34 per mo.
In other words a $300,000 mortgage, being hit with a 0.50% hike results in an increase to the payment of $80.10 per mo.
Not a radical shift.
Dollars and sense 202
Lets look at 1.5% rate hikes and what that does to payments for people starting out with a new conventional mortgage.
100K mortgage money @3% over 30 yrs. $421.60 per month
100K mortgage money @4.5% over 30 yrs. $504.22 per month
100K mortgage money @6% over 30 yrs. $594.82 per month
A pretty significant increase in rates, and the 6% rate is like several years away at this point. It seems that we have room to run up to 4.5% without hampering things too much at all.
Dollars and sense 303
Lets look at 1.5% rate hikes at renewal time over the coming 5 and 10 years, factoring in the mortgage paydown of each term (hence the lower renewal balance figures).
100K mortgage money @3% over 30 yrs. $421.60 per month
89K mortgage money @4.5% over 25 yrs. $492.59 per month
78K mortgage money @6% over 20 yrs. $555.51 per month
Again when you consider increasing rents over the next 5 to 10 years for investors holding properties, and increased wages over the next 5 and 10 years for homeowners these payment increases seem likely to be reasonably absorbed without too much trouble.
Dollars and sense 404
Here we have the option of ‘re-amortising’ your mortgage at renewal spelled out in dollars and cents. Yes this is effectively turning your 30yr mortgage into a 40yr mortgage, but as you can see it keeps the payment hikes in check and for folks in a downswing financially it offers a potential safety net at renewal time if rates have climbed significantly.
100K mortgage money @3% over 30 yrs. $421.60 per month
89K mortgage money @4.5% over 30 yrs. $448.75 per month
78K mortgage money @6% over 30 yrs. $463.96 per month
Again clearly there are methods to keep our foreclosure rate near is 0.35% level when rates to finally start to truly rise.
In conclusion;
Lose the ‘Re’ and be ‘Pro’-active. We tend to over-react to small changes in circumstance, and under-react to dramatic shifts. In my experience the two most common (and often most damaging) Over-reactions when interest rates move slightly that I see are;
- Blending & Extending
- Locking in your Variable rate mortgage (into a 5 year fixed, there are other options…)
Do not assume that as rates climb prepayment penalties fall. (for details on penalty calculations see ‘byzantine’)
The stats suggest that 6 out of 10 five year fixed mortgages will not mature. They will be broken early, at an average of 38 months. The average penalty currently for a 5 year fixed rate client 30 months into term is 4% of the mortgage balance (+/- 1%). In the fine print it states ‘the greater of three months interest of the Interest Rate Differential’.
***a variable rate mortgage only ever has a 3 months interest penalty. (not payments, 3 months interest) i.e. ~ 0.7% of the mortgage balance.
Same story in July, 2013 as Feb, 2013, as Feb 2012…
Currently in a variable at Prime minus ’X’ on your residence, with a reasonably ‘low’ mortgage? Most likely you should stay there*****although it never hurts to talk it over with your Broker..
Do you have the option to renew, refinance, or lock in investment properties at 2.69-3.39%? Seriously consider this.
Again the first step; engage an expert.
Make the best decisions you can, make them with a reasonable amount of input from professionals.
Sometimes the best action is none at all.
Thank you.