[King Tut]

I am buying my first home, and it is located in Oakville. I am only putting 10% down, and had a locked rate of 3.15% for a 3 year term mortgage (current 3 year term rates are at 3.59%). I am wondering if I might be better off going for a 5 year variable rate mortgage which currently stands at prime plus 0.4% i.e. 2.65%.

I would really appreciate your input and thoughts.

 

[MoneyGal]

Well...in evaluating this decision for myself over the years I've been a home-owner, I've always reviewed how important rate certainty (and thus fixed payments) were for me -- because that's what you are essentially buying when you lock in, and there is (as you've noticed) a premium to be paid for avoiding insurance rate risk.

In your shoes I would look at your capacity to tolerate fluctuations. How stable is your income? How correlated to the broader economy is your job? And also: how affordable is your mortgage payment under a couple of different interest rate scenarios?

When I first bought a home (this is back in 1996) I did some research at that time on the long-term effects of locking in vs. keeping a six-month open mortgage. The data at that time showed that over a fairly long period (10+ years) NOT locking in saved you more in interest payments than locking in would have (irrespective of the rates, if that makes sense to you). I would hazard a guess that's still true, although I am not going to crunch the numbers.

 

[mfd]

I second what she said.

I personally went with the certainty of a fixed rate. There are enough unknowns in life and I really didn't want to have deal with a mortgage as well. Last thing you need is a spike in variable rates at the wrong time...ie wife is on maternity leave.

 

[stephenheath]

Personally, I do the calculations a little bit differently. I assume that I would keep my payments the same whichever rate I had, and figure out what the actual interest savings in each year would be. You didn't give actual numbers so I'll just assume your mortgage is $200,000 and you pay exactly $10,000 per year in principal, so your interest differential if rates stay the same for all three years is $200,000*.005 = $1000, $190,000*.005 = $950, $180,000*.005 = $900.

Now in this case, we've already had it hinted that the central bank will keep rates where they are for about a year, so that $1000 is pretty secure. That means that rates could go up half a point and you'd still be ahead. If they went up 3/4's of a point though you'd have $1000, -$475, -$450... still ahead, but only by $75 over the entire course of the mortgage. Anything 1% or higher after the first year and you'd have been better to lock in.

As it's impossible for the variable rate to go lower for technical reasons, and it is being goosed to the max to fight deflation, personally I think the probability is very high that when they do raise rates, it will very quickly jump up 2-4%, at least, perhaps higher. The question is, which year would that be? 2010? 2011? 2012? What happens if it goes up 4% the second year? You'd have $1000, -$6,650, -$6,300, for a total loss of $11,950.

All things considered, if I weren't waiting out the end of my prime - .75, I'd be tempted to lock in for 10 years right now.

 

[King Tut]

Well...in evaluating this decision for myself over the years I've been a home-owner, I've always reviewed how important rate certainty (and thus fixed payments) were for me -- because that's what you are essentially buying when you lock in, and there is (as you've noticed) a premium to be paid for avoiding insurance rate risk.

In your shoes I would look at your capacity to tolerate fluctuations. How stable is your income? How correlated to the broader economy is your job? And also: how affordable is your mortgage payment under a couple of different interest rate scenarios?

When I first bought a home (this is back in 1996) I did some research at that time on the long-term effects of locking in vs. keeping a six-month open mortgage. The data at that time showed that over a fairly long period (10+ years) NOT locking in saved you more in interest payments than locking in would have (irrespective of the rates, if that makes sense to you). I would hazard a guess that's still true, although I am not going to crunch the numbers.

Thanks for your reply. My income is fairly stable, and I am not counting on my wife's income. I considered a couple of interest rates, and I think that the most interest I can afford for my mortgage is around 4.5 to 5%. If every body seem to agree that the interest rates can only go up from here, the question that comes to mind is how high, and how soon the interests will go up.

 

[King Tut]

Personally, I do the calculations a little bit differently. I assume that I would keep my payments the same whichever rate I had, and figure out what the actual interest savings in each year would be. You didn't give actual numbers so I'll just assume your mortgage is $200,000 and you pay exactly $10,000 per year in principal, so your interest differential if rates stay the same for all three years is $200,000*.005 = $1000, $190,000*.005 = $950, $180,000*.005 = $900.

Now in this case, we've already had it hinted that the central bank will keep rates where they are for about a year, so that $1000 is pretty secure. That means that rates could go up half a point and you'd still be ahead. If they went up 3/4's of a point though you'd have $1000, -$475, -$450... still ahead, but only by $75 over the entire course of the mortgage. Anything 1% or higher after the first year and you'd have been better to lock in.

As it's impossible for the variable rate to go lower for technical reasons, and it is being goosed to the max to fight deflation, personally I think the probability is very high that when they do raise rates, it will very quickly jump up 2-4%, at least, perhaps higher. The question is, which year would that be? 2010? 2011? 2012? What happens if it goes up 4% the second year? You'd have $1000, -$6,650, -$6,300, for a total loss of $11,950.

All things considered, if I weren't waiting out the end of my prime - .75, I'd be tempted to lock in for 10 years right now.

Thanks for crunching in the numbers. My mortgage is 376k, so there is approximately twice as much potential for loss or gain (from your calculation assuming a mortgage of 200k). If I look at the lowest current 5 year fixed, it is 4.05%. The current lowest 7 year fixed is 5.35%. If historically, the banks have always made more money on fixed mortgages, can I safely say that the average variable rates over the next 7 years will probably still be lower than 5.35%?

 

[jj12345]

Thanks for your reply. My income is fairly stable, and I am not counting on my wife's income. I considered a couple of interest rates, and I think that the most interest I can afford for my mortgage is around 4.5 to 5%. If every body seem to agree that the interest rates can only go up from here, the question that comes to mind is how high, and how soon the interests will go up.

Hey,

Just wanted to mention, if you're looking for a fixed rate mortgage (even if you're not), you may want to go to ingdirect.ca and put a hold for 120 days on the rate. I've done this as I'm thinking of switching my mortgage, but am waiting a few months to see if the rates go up so my IRD will be lower.. Bonds seem to be slowly on the way up, so fixed rates likely will too...

not trying to plug ING, but for the 120 day hold, you automatically get the lowest rate they have within those 4 months.. no strings.

 

[King Tut]

Hey,

Just wanted to mention, if you're looking for a fixed rate mortgage (even if you're not), you may want to go to ingdirect.ca and put a hold for 120 days on the rate. I've done this as I'm thinking of switching my mortgage, but am waiting a few months to see if the rates go up so my IRD will be lower.. Bonds seem to be slowly on the way up, so fixed rates likely will too...

not trying to plug ING, but for the 120 day hold, you automatically get the lowest rate they have within those 4 months.. no strings.

In my case, the closing is in about two months from now, so I have to make up my mind in the next few weeks but thanks for your input.

 

[Rickson9]

If every body seem to agree that the interest rates can only go up from here, the question that comes to mind is how high, and how soon the interests will go up.

Nobody can give you an answer to that.

If you can't afford the mortgage if interest rates double in 5 years, you should pass.

 

[Brad911]

If you can't afford the mortgage if interest rates double in 5 years, you should pass.

Excellent advice. Realistically current homebuyers have to be cautious not to get caught up in the media or RE market's attempts to make this market look attractive. Yes prices have come down, but we're no where near what prices will be if prime rates were to move above 5% in short order. Then you would see a serious correction in RE prices and only those who could really afford a home at a specific price would get pre-approved for one. Give yourself room in your budget/income to consider what would happen if rates went up. Even if you can make your payments today doesn't mean you'll be able to in the future when you re-finance. My feeling is that in 5 years time there will be a lot of people refinancing from a position of a 5% downpayment who won't be able to afford their home with where rates will be.

 

[King Tut]

If you can't afford the mortgage if interest rates double in 5 years, you should pass.

I appreciate your input. However, I cannot back out now as my offer for the house has already been accepted, and the closing is in two months' time.
The current locked rate I have is 3.15%, and is for 3 years. I have not yet signed the mortgage papers and am still shopping around for other mortgage products that may suit my situation.

To narrow it down, I think there are two options for me:

1. take the three year mortgage and hope by the end of the 3 year term, the rates will not have gone up so much.

2. See if I can get a decent 7 year mortgage (currently the rates are at 5.35%)

The first option is not as risky as it may appear because my wife will be back from her mat leave soon.