Friday, November 18, 2011

Fixed or Variable?

Find an article which addresses the age old question, "Should I take a fixed rate or variable rate mortgage?"
Rates are historically low so either option is attractive in the short term. Lenders have stopped aggressive discounting of the variable rate option so borrowers might expect to pay prime today (3%) while qualified quick closing 5 year money is available at 3.29%.

I prefer the fixed rate option because the rate difference is negligible and one gets 5 years of peace of mind. In years past it was normal to see a 1.50% spread between short term and 5 year funds.

A recent Bank of Montreal study says that variable-rate mortgages have worked out to be better than fixed-rate mortgages 83 per cent of the time since 1975.

I believe we are now in the 17-per-cent zone.

Here are three key reasons:

Protect yourself from interest rates you can’t afford
Today, Canada’s debt-to-income ratio has reached 150 per cent – an all-time high. To me, this is rational. If you can borrow money at 2 per cent or 3 per cent, it can make financial sense to borrow a lot.
Mortgages: Variable or fixed rate?

The big issue is whether these same borrowers would have borrowed as much if interest rates were 5 per cent or 6 per cent. Based on the history of five-year mortgage rates since 1950, it is rare to get a 5-year fixed mortgage for under 6 per cent.

We don’t know where interest rates will be over the next five to 10 years, but what percentage of borrowers today will have financial difficulty paying their debt at 6 per cent? For those that will be in rough shape in that scenario, a variable-rate mortgage today is a real risk.

The only way someone can eliminate that risk is to lock in their mortgage rate. Today, you can get a five-year fixed mortgage for as low as 3.2 per cent. While you still need to worry about where interest rates will be in five years, you will be protected from any interest rate increases until late 2016.

For those who are truly risk averse, you can get a 10-year mortgage today for 4.69 per cent. While a 10-year mortgage is not the right solution for many people, for some stable and risk-averse people, this could be an ideal solution to avoid any interest rate risks for a decade. Keep in mind that for most of the last half century, a mortgage rate of 4.69 per cent would have been a blessing.

The premium on fixed mortgage is very small
For most of the past year, Canadians have leaned very heavily to variable-rate mortgages. Earlier this year, five-year variable mortgages were being offered at rates as low as prime minus 0.95 per cent (2.05 per cent at current prime rates). With the latest financial worries, lenders have raised variable rates. It is now difficult to find better than prime minus 0.5 per cent on a five-year variable mortgage. At today’s prime rate, this translates into 2.50 per cent.

Traditionally, a five-year fixed-rate mortgage would be 1 per cent to 2 per cent higher than the five-year variable rate, depending on the prevailing yield curve. The yield curve shows the difference between short-term rates and longer term rates.

Today, if you can get a variable rate mortgage for 2.50 per cent, and a five-year fixed at 3.2 per cent that is just a 0.7-per-cent premium. That is a steal on a historical basis.

Now factor in the fact that today’s prime rate is among the lowest in history and there are very few people who believe that interest rates will be the same or lower three years from now. If ever there was a time to take a hit of 0.7 per cent (on the front end) for the benefit of having a locked in rate for five years, today might be the day.

Peace of mind
There are a lot of things to worry about in life. For those with a large variable-rate mortgage, I know from our clients, that every Bank of Canada interest-rate announcement brings some anxiety. Having a fixed-rate mortgage simply eliminates that extra worry for at least a few years.

On its own, peace of mind is not a strong enough reason for most people to go fixed versus variable, but in combination with interest-rate history and the exceptionally low premium for a five-year fixed-rate mortgage, I believe now is the right time to lock into a fixed-rate mortgage.

Even if you are currently in a variable rate mortgage that doesn’t come due for a while, now might be a good time to consider moving to a fixed-rate mortgage and locking in the lowest rates in history.

We may just look back at today’s fixed rates and wonder how we could have ever considered not locking in.

Ted Rechtshaffen is president and CEO of TriDelta Financial Partners, a firm that provides independent financial planning advice. He has an MBA from the Schulich School of Business and is a certified financial planner. He was vice-president of business strategy at a major Canadian brokerage firm.

Appearantly we get it!

RBC’s Nixon cites lack of loan demand for economic malaise

From Thursday's Globe and Mail

Gordon Nixon, the head of Canada’s biggest bank, says he’s desperate to lend and do his part to kick-start the economy. There’s only one problem: wary businesses and indebted consumers don’t want his money.

“Our biggest challenge right now is to put credit out,” the Royal Bank of Canada chief executive officer said Wednesday at a conference in Washington. “Loan demand is very low.”

Mr. Nixon’s remarks come amid a contentious debate over the role of banks in the economic recovery – or lack thereof.

In some quarters, there is a feeling that financial institutions are restraining economic growth by applying unnecessarily strict lending standards after getting burned by the financial crisis. The RBC chief insists that is not the case with him, nor is it the case with his rivals, with whom he is engaged in “fierce” competition.

“We have never been more aggressive,” Mr. Nixon said during a panel discussion on the financial crisis hosted by Thomson Reuters, the University of Toronto’s Rotman School of Management, the Atlantic Council and the Government of Canada. “We have balance sheet to go at all levels,” Mr. Nixon added, using bankers’ jargon to say that he’s sitting on plenty of cash that he would like to lend to households, businesses and investors.

Business loans to Canadian residents by chartered banks was little changed between June and September, oscillating between a monthly average of roughly $177-billion and $178-billion, according to the Bank of Canada’s most recent data.

Companies are uninterested in taking on debt because the global economic outlook is uncertain, clouded by the likelihood that the European economy will tip into recession. Businesses also are sitting on record profits built up during the initial burst of growth that followed the 2008-2009 recession, allowing executives to finance operations with cash on hand.

Households in Canada appear to be thinking twice about record debt levels. For example, the monthly average of personal loans by chartered banks surged to $68-billion in August from $56-billion in January, 2010, a 21-per-cent increase. But the growth of personal loans suddenly stalled in September, according to the Bank of Canada data. The monthly average of outstanding credit-card loans was $63-billion in September compared with $64-billion in April.

Mr. Nixon was participating in a day-long event hosted by the Canadian embassy meant to highlight Canada’s relative economic success during the financial crisis. Financial regulation figured prominently in the discussion, and Mr. Nixon’s remark about the weakness of demand for loans had the effect of undermining the international bank lobby’s case against tighter scrutiny.

The Institute of International Finance, the Washington-based lobby for more than 450 financial institutions, has sought to push back against the Group of 20’s move for tougher banking rules by arguing the effort is hindering the banking industry’s ability to lend.

Bank of Canada Governor Mark Carney, who was appointed to lead the Financial Stability Board of international regulators this month, has countered that argument by saying the reason banks aren’t lending is because demand is weak – precisely Mr. Nixon’s observation on Wednesday.

It was unclear whether Mr. Nixon realized he was stomping on one of the key messages of the bank lobby. Regardless, the RBC chief was on message for most of the rest of his presentation, saying the G20’s regulatory push addresses “some of the wrong problems” and that rules have become needlessly complex.

Mr. Nixon contends the financial crisis was primarily caused by poor U.S. housing policy that encouraged households to take on too much debt and banks that were allowed to let their lending grow out of proportion to the amount of assets they had in reserve. But authorities, he said, have created rules that go well beyond these core issues.

“It’s very important that we have regulation that isn’t overly complex,” Mr. Nixon said. “Unfortunately, that’s not the way the regulatory environment has evolved.”