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Mortgage interest rates rising ...
Should you float or fix?
It's more expensive than ever to buy a home in Canada as record house prices coincide with mortgage rates at five-year highs. The average sale price in urban markets was $333,524 last month, a 10.2 per cent increase from a year ago and the highest ever recorded by the Canadian Real Estate Association.
Thursday's data came as the banks jacked up their posted mortgage rates for the fourth time in less than a month, with the popular five-year closed mortgage at 7.44 per cent, up 0.85 percentage point from mid-May. The increases are blamed on higher yields on the bond market, where banks raise the money they lend for mortgages.
However, record prices and rising mortgage rates have not deterred Canadians from buying, as the realtors' association also reported a record volume of sales last month at 42,039 units, an 11.6 per cent increase from a year earlier.
"Activity broke all previous records in the first quarter, and gained momentum in the second quarter," Klump said. "The increase in transactions for the year-to-date suggests activity is on track to set a new annual record this year."
Even with rising rates, the housing market is expected to remain strong, especially in the hot economies of Western Canada.
While long-term mortgage rates have been climbing, the prime lending rate which defines variable rate mortgages has been at six per cent for more than a year - but looks likely to start rising as early as July 10, when the Bank of Canada makes its next rate-setting decision.
That means anybody with a variable rate mortgage will face increased payments, renewing the question: should I lock in, and if so, when?
Homebuyers researching variable versus fixed rates should start with some introspection: How willing and able are you to assume some risk?
If you sign the dotted line on a longer-term mortgage, you'll have the predictability sought by many first-time home buyers.
If you choose a variable rate, you'll benefit from lower interest rates in the short term, but risk a spike if the Bank of Canada tightens sharply to restrain inflation.
"If you can afford to, and are okay with your rates changing . . . in the long run you're better off with a variable rate mortgage," said Gregory Klump, chief economist of the Canadian Real Estate Association, noting that the reason is simple - short-term rates are almost always lower than long-term rates.
"For those who need the certainty of what their mortgage is going to be, I would advise, if they're not already homeowners, get a pre-approved mortgage. That way, if rates go down the day your mortgage closes, you get the better of whatever the pre-approved rate is or the rate at that time, whichever is lower."
It's rare that homebuyers pay the full posted rate, which can typically be discounted by a percentage point or more on a five-year term.
Bob Dugan, the chief economist for the Canada Mortgage and Housing Corporation, says it depends on the buyer's financial ability to assume a hit if rates move higher.
"Each household has to look inward," Dugan said. "You don't want to go with a variable rate and then have a lot of sleepless nights, worrying about interest rates going up."
Dugan said more than half of mortgages currently held by Canadians have fixed rates.
Moshe Milevsky, a finance professor at York University and executive director of the Individual Finance and Insurance Decisions Centre, divides homebuyers into four groups in a paper entitled "Mortgage Financing: Should you still float?"
- The first-time home purchaser, particularly buyers with small downpayments, are the most likely customer for the long-term fixed rate mortgage. "These folks should not be taking any chances with a fluctuating interest rate," Milevsky wrote, noting if the value of the house falls they could be left with "negative equity."
- For the "risk-averse worry wart," Milevsky recommends splitting your mortgage in two halves, with one set at a variable rate and the other locked in.
- The "seasoned veteran," with more equity built up in the home and two incomes, is in a better position to take a risk with a variable rate mortgage, Milevsky says.
- The "financially savvy arbitrageur" can shop around for the best rate with this strategy: Get a pre-approved fixed rate mortgage, guaranteed for up to four months.
Then get a floating mortgage with the option to pre-pay the whole thing off without penalty. Follow the Bank of Canada and the bond market. If rates increase, move the mortgage to the bank which you gave the pre-approved rate. "Otherwise, do nothing and start the process over in a few months," Milevsky wrote. "Understandably, the bank manager might get a bit weary of your constant requests for pre-approval."
June 15, 2007 in Arranging Mortgage Financing | Permalink
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Comments
Even with the US sinking fast we in Canada are not. Is this just lag time before we do the Titanic?
Posted by: Ontario Real Estate | Jun 15, 2007 5:06:58 PM
