By Madhavi Acharya-Tom Yew | Fri Apr 27 2012
The search for the right mortgage can make a person feel a bit like Goldilocks: On the hunt for something that is not too short, not too long, but just right.
For Ilda Dinis and her partner, Ryan Johnsen, that meant choosing a five-year term with an interest rate of 3.19 per cent for their new home in the High Park-Junction area.
“We keep hearing that rates are going to go up. This was a great rate, and to have it locked in for five years gives us a lot of comfort,” Dinis said.
Mortgage experts will tell you that your down-payment, the length of the amortization, the term you choose, and pre-payment options, as well as the interest rate, are all important factors when it comes to paying off this massive debt as quickly as possible.
Today’s homebuyers tend to be focused on the record-low interest rates.
How much longer will they last?
In mid-April, the Bank of Canada kept its benchmark interest rate unchanged, but governor Mark Carney again warned that Canadians should get their household finances in order because interest rates hikes are on the horizon.
Of course, we’ve all heard that one before.
The central bank’s overnight rate has been stuck at one per cent since September, 2010, largely because of worries about the health of the world economy and the ongoing debt crisis in Europe.
Since then, warnings that these low rates wouldn’t last long have been incessant.
“Two years ago, I was listening to economists and telling clients this is a short-lived thing, get your rate today, two or three years from now, rates will be back up,” said mortgage broker Brad Compton.
“Here we are two years later and rates are in roughly the same position as they were back then.”
Here are the factors economists cite to show it’s different this time: the recovery in the U.S. economy is picking up steam; Canada’s economy is strengthening and there are mounting worries about Canadians’ household debt levels and these things make it all the more likely that rates will increase later this year or early next.
“Over the past couple of years I have felt like the little boy who cried, ‘Wolf!’ I have repeatedly warned Canadians to be careful with their finances, because interest rates are bound to rise eventually. I said that at the start of last year, and interest rates ended the year lower,” Craig Alexander, chief economist at TD Bank Group, wrote in a recent commentary.
“Regardless, I keep stressing that you have to read the book; the wolf does show up at the end. Well, the Bank of Canada’s messaging this week suggests that the wolf is getting closer and there aren’t too many pages left.”
TD Bank expects that the overnight rate could rise by half-a-percentage point this fall and another half-percentage point next spring.
That, in turn, would send the bank’s prime rate higher, and variable mortgage rates would also rise.
Fixed rates are on the rise, too, but for different reasons. These rates are tied to borrowing in the bond market, where supply and demand, and, therefore prices, can fluctuate according to world events.
“The bond yield has jumped up from where it was previously,” said Kelvin Mangaroo of RateSupermarket.ca. “That’s what has really driven the fixed mortgage rates up.”
In January, the Bank of Montreal grabbed headlines when it unveiled a fixed rate of 2.99 per cent on a five-year term.
It was a gloves-off grab for market share at a time when banks are expecting Canada’s red-hot real estate market to cool off. Other banks were quick to match the offer, even as they called the deeply-discounted rate unsustainable.
Many of those offers have now expired, and five-year rates are sitting in the low three-percentage range.
But, because these rates are still well below historical averages, it’s still the right time to lock-in, experts say.
Consider that the prime rate in Canada, which stands at 3 per cent, has actually averaged 4.19 per cent over the last 10 years, according to CanEquity.com, a popular mortgage website.
The average three-year fixed rate has been 5.65 per cent over that time, and the average five-year, fixed mortgage rate is 6.27 per cent.
“Being able to lock in for 10 years at an interest rate below 4 per cent, you really can’t go wrong with that,” Compton said. “It’s going to allow you to have security and peace of mind and allow you to ride out any wild rate fluctuations that we could see over the next three to five years.”
A shorter term may be a better fit for someone who is confident they will be able to pay the mortgage off in a couple of years and doesn’t want to get hit with penalties.
If you’re tempted to consider a shorter term because you may be selling your home in a couple of years, keep in mind that you may be able to take the mortgage with you to your new property, or the person buying yours may take it over, assuming he or she qualifies, Compton said.
After putting in offers — and losing out on — 10 different homes, Dinis and Johnsen finally landed a detached home, a bit bigger than their current one, on a quiet, family friendly street in her neighbourhood.
The couple and their two sons, ages 11 and 9, will move in July.
Referring to the many bidding wars they endured during their search, Dinis said, “You get emotionally attached. You start envisioning your stuff there and kids in the backyard but then you have to let it go, because you know that you need to be rational about it.”
Choosing their mortgage rate and the terms took similar focus. There were lower rates out there, along with shorter and longer terms to consider.
They ruled out a variable rate because they preferred the security of locking in.
The 10-year rates, as low as 3.99 per cent, seemed attractive, but a decade just seemed like too long a time to lock-in, Dinis said.
The couple also considered a four-year term with a rate of 2.99 per cent, but the pre-payment terms (the ability to pay off the principal without penalties) were not as generous.
“The difference in the rate was nominal and there were more penalties for paying it down early,” Dinis said. “It felt restrictive. If you can’t take advantage of the low rates to pay it down, what’s the point of getting a low mortgage rate?”
They decided to grab the five-year rate, and take advantage of their pre-payment options whenever possible.
“We’ve crunched the numbers six ways to Sunday. We know we’re getting a great deal and we can pay down more on the mortgage at that rate as well,” Dinis said.
“This is definitely my dream house. This will hopefully be it for many, many years.”
Ilda Dinis had a lot to consider when choosing a mortgage:
• Fixed rate vs. variable: Choosing a fixed-rate allows her to lock-in a set mortgage payment each month for the length of the term, without worrying about fluctuations in the bank’s prime rate and the Bank of Canada’s overnight rate.
• Length of term: The term is the length of time you commit to the mortgage rate and lender. Terms range from six months to 25 years, but most Canadians choose a mortgage term of five years. When the term is up, you renew your mortgage on the remaining principle. The rate is likely to change at that time.
• Pre-payments: Homeowners are allowed to increase their monthly payments or make lump-sum payments without penalties, up to a certain annual maximum — typically 20 per cent of the principal. Some mortgages that offer a special low interest rate may be more restrictive.
Rates then and now
Today’s low rates are a steal. Here’s a comparison using historical averages:
• Borrowing $400,000 at 3.19 per cent for five years with a 25-year amortization:
The payments are $1,932.19 per month and the remaining principal at the end of the term is $343,137.56. The total interest paid at the end of the term is $59,068.96
• Borrowing $400,000 at 6.27 per cent for five years with a 25-year amortization:
The payments are $2,623.77 per month and the remaining principal at the end of the term is $360,698.59. The total interest paid at the end of the term is $118,124.79.