The Lock Down is On

Lock-in-Mortgage More people seem to be locking in right now than at any time in the last year.  It seems people still put a high value on certainty, despite all the data about variable-rate superiority.

So that begs the question: Are variables becoming passe for the moment?

In our view, not at all. 

Prime rate would probably have to rise at least a couple of percent for most people to be better off in a fixed for the next five years.  Of course, if inflation heats up as expected, that’s not totally out of the question. 

It’s largely an odds game, and the odds (i.e. research) favour variables in the long-run, despite what’s happening today.

Trouble is, a lot of people don’t trust the odds.

If you do trust the odds, there are still a few lenders near 4% on a variable–an outstanding rate from a historical standpoint.  Add in a fixed payment and it’s like having the best of a fixed-rate and variable-rate mortgage.  You’ll get a much better rate right off the bat, and have just a little more payment risk (due to the trigger rate) than you would with a fixed-rate mortgage.

  1. I remember going to the bank in the late eighties and buying a GIC at 20+% as a way of keeping my university money busy until I needed it. People are probably remembering similar things when they’re chosing to lock in.

  2. My broker thinks there will be maybe a 1% increase by the end of 2009 to the variable rate which still keeps it below most of the fixed rates out there now. Has anyone else heard anything regarding an increasing variable rate? I am new to all of this as I just bought my first home and trying decide whether to go fixed or variable.

  3. Let’s see.
    A risk-free/certainty 5.15% fixed for 5 years vs. a 4-something variable?
    Why stress over rates for the next 5 years? Just lock in!
    How greedy do you have to be not to lock in a historically insignificant 5% fixed????
    Ohhohoo, you’ll save a few pennies IF rates stay between 4 and 5.
    But you’ll get your socks knocked IF rates go back to the 7-10 range and then you’ll lock in at a higher rate out of fear!
    IF vs. Certainty, depends if you are a gambler or not.

  4. Hi Al: No doubt!
    Hi Michelle: Most economists are looking for an uptick in rates in 2009. That said, predicting rates is a pure crap-shoot. Better to look at your personal situation (income, job security, equity, risk tolerance, etc.) and decide based on that.
    Hi Jim: Fair point and thanks for the comment.
    What we find is that our business has at least two types of gamblers:
    1. People who really should be in a fixed today, but are waiting for rates to drop (or those getting a variable in the short-term, hoping to lock in later); and,
    2. People who should be in a variable (or hybrid) but get a fixed instead.
    For anyone that doesn’t meet the variable criteria you’re absolutely right. We tell these folks the same thing. Greed is bad, despite what Gekko says.
    However, for people that do fit the variable-rate profile (a lot of equity, great jobs, etc.), the long-term research on variables must be considered. Many would say that people who lock into a fixed are actually the ones taking the risk because they’re hoping a fixed will come out ahead despite the historical numbers.
    In any case, if someone if basing their fixed/variable decision on today’s rate increases, and projecting rates going forward, one could argue that they are the biggest gamblers of all.

  5. I was once told, in commercial negotiations with a client that “every risk carries with it a price”.
    There is no “risk” in taking a fixed rate mortgage. That fact that you are very likely to pay more is not a “risk”, it is the price you pay to eliminate your risk. If you can just manage your 5 year fixed, it’s probably not a bad idea to lock-in, because your risk is high.
    Do the math (or ask your broker to help you do the math) and figure out approximations for how much you would “save” on a variable if interest rates stay constant, and how much it would “cost” you on a variable (and what your payments would climb to) if interest rates went up 1% per year for the next 3 years. If the latter will keep you from sleeping (or make your payments impossible), then you might consider locking in: there’s no shame in paying to eliminate risk.
    A good night’s sleep is valuable too!

  6. I was strongly looking at a variable but the last couple of weeks of news has pushed me to a fixed. I am somewhat risk averse and I like the idea of signing and forgetting and not worrying about every rate increase. Sleeping at night is important to me since I am busy with work, life and don’t need another piece of stress in my life. This also helps me manage my budget. I was lucky enough to lock in @ 4.99 for 5 years so in the end it works for me.

  7. Chris
    Taking a fixed rate will almost certainly cost you money 90% of the time. If you lock into a fixed mortgage there is only a 10% chance you will come out ahead. This is the research. I am not making this up.
    So if you choose a fixed you are most definitely taking a risk. The risk is that you lose money if you are wrong. We shouldn’t let the meaning or definition of “risk” obscure this point.

  8. Hi,
    Like all that said it before, thank you very much for all the information on this site. It is awesome.
    I am new to this and having a fix-payment variable right now, the question/concerns that I have is, how fast do rates normally climbed up? Is it realistic for prime to be over 7% from 4.75% in the next 3 – 4 years? I have the mind set where I think if I were to lock, I want to try to lock-in in the middle of the rise and finishing the term during the fall of the rate. I fear that if I lock-in now, in 5 year, there is a good chance the rate will be at its peak or on its way to the peak. Is this a wise thing to do? I can lock-in with a term equivalent to or greater than the remaining term.

  9. Hi Chris: Thanks very much for the comment. Point taken. I’ve never myself considered fixed mortgages as “risky” so to speak, but I know of several others who feel this way–if only because of their historical cost disadvantage. I guess the “risk” label is all semantics in this case.
    The fact remains, as you put it, that people pay for fixed mortgages for a reason. There’s nothing wrong with that if it’s what they want. It’s like buying insurance. Although, some would say that the cost of this insurance is too high. That’s exactly why we like to feed this debate to get different people’s perspectives. Anyways, thanks again for your thoughts!
    Hi Ed: Regarding my note to Chris, you are a case in point when referring to the “risk” element of variables.
    Hi Kyle: Thanks for the note. First off, I suggest talking with a mortgage planner to get some good direction. In the meantime, here are a few things to consider:
    * Prime can increase slowly or quickly depending on the economy. Historically there have been times when prime has shot up a few percent in a year. Other times it has taken 2-4 years. No one can predict what will drive rates this time around. It’s better to base your decision on your ability to handle rate increases and your net worth.
    * Rate predictions are generally not worth the paper they’re written on. That said, I bet if you polled 100 economists less than 5% would say we’re near a multi-year peak in rates right now. Will rates peak five years from now? Refer to sentence #1. :)
    * Remember that when you lock in a variable rate, that variable rate does not turn into a fixed rate. Instead, you get the conversion rate. That’s generally much higher. Here’s a hypothetical example:
    Your variable rate today: 4.00%
    A good fixed rate today: 5.25%
    …now suppose prime goes up 2% in two years.
    Your variable rate then: 6.00%
    A good fixed rate then: 7.25%
    Your conversion rate then: 7.50%
    These numbers have no basis other than as pure random examples, but it gives you a rough idea of what could potentially happen if spreads stayed the same as today. In this example, if you lock in after two years, you might get 7.50% whereas you might get 5.25% in a new fixed mortgage today.

  10. Jim – it looks as though others have beaten me to the punch, but I couldn’t disagree more. Going with a variable is smart – not greedy. The research bears it out.
    This isn’t to say that there aren’t good reasons for going fixed (e.g. employment might be tenuous, debt service ratio might be maxed out), but in my own case, in month 4 of a 5 yr variable term (p-0.95%, 20 yr am, accel. biweekly):
    1) I am enjoying a rate of 3.80% at the beginning of my mortgage, which is lopping a huge amount of interest off, which in turn won’t compound for 2+ decades; and,
    2) Because I have a ‘fixed payment’ variable, the extra bit of my payment that would normally go towards interest is paying down the principal even faster. In fact, in the 4th month of my mortgage, most of my payment is already going towards principal.
    I don’t expect this to continue indefinitely, but right now it’s fantastic, and for me to come out behind, rates need to rise dramatically, and for an extended period. They might, but the odds are overwhelmingly on my side. I can live with that.
    The conventional wisdom is that interest rates are set to rise, but as has been repeated (and demonstrated) time and time again on this blog, no one can accurately predict future interest rates.
    Furthermore, if interest rates should rise dramatically, I’m shielded because my payment is fixed. I can also lock in at any time.
    Again, there may be legitimate reasons for people to go fixed, but making blanket statements to the effect that fixed should be the clear choice for everyone is simply not correct.
    Al R

  11. You are right about fixed not being right for everybody. My mortgage is almost paid off after next 5 years but if I had a jumbo mortgage I guess I would try to save every penny I can. Also I live in Montreal area and I can understand Vancouver and Toronto house prices are insane so gotta save!
    I also remember the days of 10+% interest rates and 5% just seems so cheap not to lock into so I am looking at things for an experienced historical perspective.
    As for those 90% of studies showing variable is better than
    fixed, I am sure they include fixed rates from the 5.5% to 7% rates but if you took the low end of the fixed rate cycle, currently at 5%, I am sure it could beat out variable half the time. Agreed at 5.5%+, take variable hands down until rates fall back.
    Finally, to paraphrase a popular commercial, variable might be less $ but not having to worry about rates for 5 whole years is priceless!
    Happy Fathers day to all!

  12. This is an excellent blog. It has helped me a lot as I try to make a decision about my own impending mortgage renewal. Thanks to the authors. I don’t have anything to add about the points already made on both sides of the fixed vs variable debate. I would only say, though, that — based on everything I have been reading about the current turbulence in financial markets and what this says about the US and British-led “neoliberal” (or neocon/”free market”) model in place since the Reagan-Thatcher years — it seems to me that this time around all bets are off as far as comparing with historical trends of the past 25 years. The chickens now appear to be coming home to roost after a quarter century of privatization, deregulation, public-sector cutbacks, union-busting and huge tax cuts for corporations and the rich, not to mention balooning deficits fed by massive military spending. I don’t know if all this means you should lock in or not, but I definitely do think it means one should be extremely cautious — ie. much more so than usual — about using historical models as a guide for what’s coming over the next decade or so. This goes not just for how mortgage rates will move, but also as far as other factors related to our decision — such as job security, wage increases, utility costs, property-tax rates and the like. As any good broker should say, you have to look at the “whole picture”. Except for the fairly small proportion of the population who have hugely benefited from the Thatcher-Reagan model, the coming years will be uncertain times.

  13. Hi….I am very new to this and have a 5.6 fixed (5 year term) with my broker however I’ve spoken to another broker who has given me 5.2. As I’ve already signed and sent back my appl to the first broker would it be too late to go w/t the 5.2 rate (only 3 years.) I’ve also forwarded my lawyers info to the broker. Please inform is it a good idea as the second term is only 3 years. Also plese inform if it’s too late to go w/t the 5.2…….Thanks, Shennell

  14. Ask the first broker if he/she could have got you that 5.2% rate also.
    If the answer is yes then ask the first broker why they didn’t suggest it.
    If the answer makes little sense then go to the other broker.
    If the answer makes sense, then stay with the first broker.

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