The question that all mortgage borrowers ask us most often:
Is it better to opt for a fixed- rate mortgage or variable rate mortgage? For several years, the classic answer was always: it depends on your cash flow and your tolerance for risk, but the variable rate mortgage or short term has been more advantageous in the long term. Example:
During the period 1950 to 2000, a Canadian borrower would have paid on average $ 22 000 in interest over costs on a mortgage of $ 100 000 amortized over 15 years, opting for fixed rate mortgages for five years instead of variable rate mortgages. The only advantage had been a greater peace of mind that payments are fixed and do not change for five years.
Those who felt that this peace of mind was too dearly paid for were right. This is not necessarily true today, some time ago, you could have negotiate a variable rate at Prime less 0.8%, it currently trades at Prime + 1%, or 3.5% at we are writing these lines, while that we can obtain a term of five years to 3.75%, the margin is very thin!
Data from the Canadian Association of Accredited Mortgage Professionals (CAAMP) show that only 27% of Canadian mortgages were at variable rates in the fall of 2008. However, this increases to 40% for mortgages contracted in the past 12 months. The popularity of variable rate mortgages has increased in recent years. It seems that this trend has accelerated since.
THE FINANCIAL CRISIS THE CHANGE
The most visible impact of the crisis is good for mortgage borrowers. The significant decline in interest rates in Canada and the fall in bond yields led to a reduction in retail rates. The rate on a fixed-rate mortgage for five years went from 7.25% in June 2007 to 3.75% today, a historic low. Meanwhile, the variable rate cut, which requires a commitment of five years rose from 5.70% to 3.50%.
Note that this phenomenon is observed everywhere in the world. The variable rate mortgages have been particularly affected by these changes. First, rather than offer variable rate mortgages at a rate slightly below the prime rate, lenders are now asking for new borrowers to pay the prime rate plus a premium of approximately 1%. Secondly, the difference between the rate of financial institutions and the rate of the Bank of Canada (BoC) has been increased by 25 basis points in December.
In the current very low interest rates, these changes have little impact on households, but what would happen when interest rates will resume an upward trend? Finally, the financial crisis has prompted the Canada Mortgage and Housing Corporation (CMHC) to tighten its eligibility criteria for mortgages. This has increased the maximum period of amortization of a mortgage to 35 years rather than 40 years.
In addition, CMHC is now requesting an investment of 5% and a minimum credit rating.
BE CAREFUL IN THE FUTURE
Are the changes observed in the Canadian mortgage market will be sustainable? It is difficult to answer this question, especially as the turbulence does not yet seem about to end. It is likely that the premiums charged by mortgage lenders decline as financial tension to resolve, but they remain significantly higher than before the crisis.
For mortgage borrowers, an assumption would be acceptable to assume that the conditions remain as they are now. A borrower who opts for a floating rate mortgage can be assumed that the gap between the prime rate and the rate of one day of the BoC remains constant throughout the duration of the loan. Under this assumption, a loan at prime +1%. However, variable rate borrowers should be aware that the prime rate remains at the discretion of financial institutions and it could vary in relation to rates.