Garth Turner on Variable/Fixed mortgages – bad advice

On Garth Turner’s “Bingo” post on March 29, 2010, he states:

But the big question I was asked today: what should you do about your mortgage?

The bankers will be on the phone to you soon ‘suggesting’ you lock in, ‘for your own protection.’ Have none of it, if you are in a cheap VRM. We know why the lenders are saying that, since they count on scores of people now rushing in to voluntarily increase their payments. Once again, they play the emotional card, consistently suggesting actions counter to the best interests of Canadians.

A prime-minus VRM is a gift. Keep it. The Bank of Canada rate would have to soar by more than 200 basis points (2%) by Christmas for you even to consider locking in. And even then you would be saving money staying variable. In fact, the typical prime minus one half borrower would be better off staying put until the prime mushroomed almost 4% above current levels. You’d still be paying less a month.

And a prime rate of 6.25% is not going to happen for two, three or perhaps four years. Any sooner and you could mop up the economy with a Swiffer.

Right now, a 5-year variable rate mortgage is prime minus 0.5%, and if you shop around, the 5-year fixed rate is 3.79%.

Prime is currently 2.25%, and should rise to 3.50% by the end of the year. Markets currently suggest the prime rate will be 4.75-5.00% at the end of 2011.

Thus, a variable rate mortgage, locked at prime minus 0.5%, should have a higher rate than a fixed rate mortgage sometime in the second half of 2011.

If prime stayed at 4.25% for the rest of the 5-year term, then a variable rate mortgage is still a cheaper option. However, the differential between the two is close enough that for most everyday people, I would still suggest a 5-year fixed rate if you can get 3.79% for it. It is highly likely over the 5-year period you will outperform the variable option, especially if the yield curve starts to invert (which will happen if the economic recovery runs out of steam).

The crystal ball becomes considerably more fuzzy if you use a 4.39% 5-year fixed rate (which is currently what is ING Direct’s posted rate). If rate increases in 2012-2014 moderate, then taking the variable rate option will be a winner. However, this is exceedingly difficult to predict.

Either way, the lack of ultra-cheap credit will have the effect of slowing down demand in the housing market. Whether that will translate into lower prices remains to be seen. Personally, I have long since thought the housing market was irrational beyond belief, but have come to accept it could be that way for longer than my lifespan.

Ultimately, the only time that housing will become “cheap” in Vancouver is likely when people don’t want to buy houses when mortgages are so expensive that GICs start to become an attractive investment option. Just imagine living back in 1982 when you had a choice of buying some Vancouver special for $150,000 on an 18% 5-year fixed-rate mortgage or renting and putting your would-be down payment in a GIC earning 15% and not having to worry about making those $27k/year interest payments… in situations like that, the cost of capital becomes so high that renting becomes a much more viable alternative.

If we ever see those days again, where buying a house is very difficult because you have such more financially attractive (and accessible) options elsewhere, I would suspect valuations are ripe for buying. We are a long way away from this, even if mortgage credit is given out at 5%.

1 Comment
Inline Feedbacks
View all comments

Although this post is quite dated, I do agree with the fact that the prime-minus variable rate mortgages are great. While I am often asked by my clients about “which is better, fixed or variable,” I often tell them that it should be based on their fluctuation comfort level. My personal home mortgage, which I have had for the past three years, gives me prime minus 85 bps. It has served me very well, having paid a grand total of 1.85% for the first few years and now I am paying 2.15%. Unfortunately, the variable rate mortgages are not offering the same sort of incentives. Rates are hanging around the prime mark, which is still saving you anywhere from 20 to 50 bps, depending on where you get financed.

Even though the variable discounts are not that great, I still think it is a good idea for the short term – especially if the bank will let you lock-in at anytime.