Variable mortgages (almost) always win
Whether they're taking on new mortgages or renewing ones they've held for
years. homeowners end up asking themselves the same question: Should
they lock intheir mortgage or should they let itfloat with a variable rate. Here,
Toronto.based wealth manager Scott Tomenson makes the case for variable.
~ ARE VARIABLE MORTGAGES AS GOOD AS THEY LOOK?
Q: My fiance and I have just bought our first home and we are going in circles about
what is the best mortgage for us before we close. We currently have a locked-in fixed
rate with a bank of 3.98%, which we prefer to the uncertainty of taking a variable mortgage.
But would we be better off with a variable-rate mortgage, especially if we saved
money during periods when rate are low and use that to make payments on principal?
Will that offset costs when our payments are higher than our current fixed rate?
Getting Dizzy, Ontario
A: Historically, as far as interest rates are concerned, it is better to float your mortgage
interest rate (i.e., choose a variable rate mortgage). This is a result of the "yield curve."
The "normal" yield curve is positively sloped, with interest rates lower for short-term
maturities (one to two years) and higher for longer-term maturities (five to 30 years).
When the economy strengthens, the Bank of Canada will raise short-term interest rates
(they only have control over short-term rates) and the base for variable-rate mortgages
(usually the prime rate) is moved higher. This action signals a period of "tightening" of
monetary policy to cool the economy and reduces inflationary pressures.
The vehicles that determine longer-term interest rates - bonds - tend to move
according to inflationary expectations: If bond investors anticipate inflation (because
of economic growth), they demand higher returns (interest rates) as protection from
inflation. When the Bank of Canada is perceived as "fighting" inflation by raising shortterm
interest rates, long-term rates have a tendency, in most cases, to remain stable or
improve, because long-term bond investors are content that inflation will not grow.
In essence, while short-term interest rates may go up, they do so only until the Bank
of Canada has slowed the economy enough to curb anticipated inflation. Then, as economic
growth slows, the bank starts to lower them. The yield curve will flatten (with
higher short-term interest rates) for a time, but when the economy slows, short~term
rates will go back down and the yield curve returns to its "normal" positive slope.
Over this time, variable-rate mortgages will move up to being approximately equal
to locked-in five- or to-year rates, but that's followed by a period when they return to
lower levels. More often than not, over this time, it is less costly to have held the variable
rate debt. Exceptions to this situation would be times of hyper-inflation (like in the
1980s) when short-term interest rates went to extreme levels.
If you had a variable mortgage at prime minus over the past few years, as I did, it's
been a great ride. I kept my payments level and the low ihterest rates allowed to me to
payoff massive amounts of principal. True, the economy is strengthening and shortterm
rates will go up a bit over the
next couple of years, but I don't think
it will be dramatic. The case for variable-
rate mortgages remains strong.
APRIL 2010 FPM41