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Mortgage Interest Rates Are Going Up & Down

Fixed Rates Down But Variable Rates Up. Confused?

Nothing like a bit of financial reading on a Sunday morning! But please bear with me. “What type of mortgage” is one of the most frequent questions I hear.

Here’s a simple overview of variable and fixed rate mortgages in the wake of last week decision by two of Canada’s biggest lenders to cut their fixed mortgage interest rates. RBC cut their 5 year lending rate and were quickly followed by BMO.

With the new mortgage qualification requirements introduced earlier this year a drop in the 5 year rate is good news and improves mortgage affordability for those who otherwise might not qualify.

However variable rates are rising after the Central Bank raised the prime lending rate another basis point to 0.75% in July.This was the second increase this year and had been expected.

Why the seeming contradiction with rates going up and down?

Fixed Rates Follow Bond Market:
Fixed rates are tied to the bond market, and when bond yields drop, so do fixed rates. Last week’s announcements by RBC and BMO were in response to an unexpected jump in bond prices, which drove yields down.

Prime Rate Governs Variable:
Variable rates, however, are tied directly to the prime lending rate, and move up and down in step with the Bank of Canada’s announcements.

What type of mortgage to choose?

There is no answer to this as each individual is different.

Some people prefer the security of knowing what the payment would be each month for the next 3 or 5 years. A fixed mortgage means you do not have to worry about changes in the prime lending rate. Just be aware that when the fixed rate term ends you may be in for a shock as rates could then be much higher.

Others want to pay less each month and the variable rate will be cheaper when you start the mortgage. BUT rates can rise and you have no control over this. The variable rate can exceed the fixed rate, be prepared to meet higher payments as the prime rate rises.

Historically variable rates have worked out to be the better deal – in the long run.
A study by York University professor Moshe Milevsky compared fixed and variable rates from 1950 to 2007, and found that most of the time – 89% of the time – variable rates outdid fixed rates. In fact, Professor Milevsky found that a $100,000 mortgage on a variable interest rate would save a staggering $20,000 in interest payments over just 15 years, compared with a fixed rate.

This entry was posted on Sunday, August 15th, 2010 at 10:11 am and is filed under Financing. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.

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