Mortgage, Money and Dream – Our thoughts on Canadian Mortgage Market
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You have heard so many times about risk and stability aspects of variable and fixed mortgages. You also did your research to understand the two and yet you remained as confused as you were. Do not blame yourself for the confusion. As a matter of fact most pundits in the field remained as confused as you are.

 

As an example take a closer look at Bank of Canada. It has a mandate to promote financial stability. It also works as a backstop to the Canadian currency. The lender of last resort ensures that the value of our currency remains same all over the market. It provides liquidity to market. Without the liquid wrench from BoC a lot of mountains would have turned into mole hills by now.

To provide long term stability to the market – the main weapon the bank has is short term rate. It is a confusing matter indeed. The logic of how the overnight rate impacts market is a very complex one. The bank also sells bonds to control the amount of liquidity available in the financial bazaar.

After doing all these and knowing so much – if you read any of the central bankers speech, you shall find they are kind of confused about the future as well. So, you are not alone.

Back to our topic now. Deciding on fixed or variable require knowledge of future. Honestly we can never predict it perfectly. You may find that our knowledge may be as close as Wiarton Willie on weather prediction. Therefore what we rather chose to do is to prolong the period of certainty. Instead of walking the path of overnight rate we decide to walk the bond rate.

As of today variable rate and fixed rate are almost the same for a five years term. Fixed rate is so low that you may rarely see any serious slack in the rate for a future drop. Therefore while comparing five years fixed and variable, clearly fixed does not look as bad. Furthermore if fixed rates go up in the future then you may also win on the penalty side.  

The story turns interesting when you start to compare apple to orange, like a five years variable rate versus a three years fixed rate. You can easily bag a 3 years fixed rate for somewhere close to 2.75% and a two years fixed at 2.4%. So, shorter your term, cheaper the carrying cost. Not to forget that if you want anything less than five years term you have to qualify for the loan with a 5.24% interest rate.

Short term variable rates are also very attractive. A three years variable is about P-0.4%. That gives you a current rate of 2.60%, lower than a three years fixed.

Very short term rates are a different story all together. Last year, many banks were offering ultra-low rate for one years fixed mortgage, they all but disappeared from the market now. Today anything less than a two years will cost you more than a two years fixed rate. So, the borrowers are discouraged to take a very short term rate now. That indicates that the liquid wrench is drying up.

Right now Bank of Canada has few problems on its plate –

  • Record Government debt – backed by low yielding bonds.
  • Record household debt – backed by low overnight rate.
  • Uncertain international outlook (including US fiscal cliff).
  • Weak Canadian recovery.

In future, once majority of those turns around the remaining will self-correct themselves. BoC will have no hesitation to pull some liquidity out of the market. The marginal buyers will face real challenge, once that happens.