Hybrid Mortgages Catching On

mortgage-rate-diversification Investors like to avoid putting all their eggs in one basket. But this philosophy has been slow to catch on in the mortgage market.

94% of people still choose either fixed or variable rates, says CAAMP. Very few choose a combination of both.

That may be changing, if yesterday’s RBC/Ipsos Reid poll is right.

According to RBC, 40% of prospective homebuyers (people who plan to buy in the next two years) intend to take out a hybrid mortgage. That compares to 32% in last year’s survey.

These stats are a little hard to grasp given CAAMP’s recent mortgage survey. It suggests only 6% of Canadians have actually chosen a hybrid mortgage in the last year. However, Ipsos Reid’s Sean Simpson, says: “I would account for the difference by saying that one is an outlook while the other is retrospective.”

Simpson notes that, “Looking forward to the next two years, there is much more uncertainty in the direction of interest rates.” He says that Hybrids are, therefore, becoming more attractive since they let people capitalize on low rates while retaining an element of security.

Based on what an RBC spokesperson told us, hybrids may be catching on fast. In terms of the number of new buyers choosing hybrids, RBC says: "We have been trending similar to the survey results over the last quarter."

Marcia Moffat, head of Home Equity Financing at RBC, adds: "As consumers begin to learn about the benefits of mortgage diversification, we're seeing more homebuyers gain a better comfort level with adding floating rate mortgage options."

From our own anecdotal observations, that appears to be the case. We’re not seeing anywhere close to 32-40% of borrowers choose hybrids, but there’s been a noticeable increase in hybrid mortgage inquiries compared to last year.

The academic research supports hybrids as well. Dr. Moshe Milevsky–Canada’s most quoted mortgage researcher—says: “Nobody can truly predict how rates will move over a five-year period. It’s just that simple.”

He, therefore, believes hybrids are a good form of mortgage risk management. “People should strongly consider mortgages that are part fixed and part floating,” he told us last year. Interest rate diversification benefits borrowers just like it benefits investors who buy portfolios of stocks.

Of course, if history is a guide, well-qualified borrowers may save more money by simply choosing an ultra-low variable rate, or a 1-year fixed. But not all borrowers are in the same boat. Homeowners with only moderately strong personal “balance sheets,” can’t afford to dismiss the concept of risk management. 

Many moderately-strong borrowers will, in fact, assume the risk of putting 100% of their mortgage in a variable rate. These folks will probably never realize the value of rate diversification/risk management unless the “worst case” materializes…and then it’s usually too late.

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Sidebar:  Here’s a partial list of lenders who currently offer hybrid mortgages:

  • ATB Financial
  • Canadiana Financial
  • HSBC
  • Laurentian Bank
  • Merix Financial
  • National Bank
  • RBC
  • Scotiabank
  • Various credit unions

If we forgot any major ones, let us know and we’ll add them to the list.

This list does not include all lenders that offer readvanceable mortgages.  Readvanceable mortgages often include a fixed portion and line of credit (LOC) portion. That technically makes them a form of hybrid mortgage as well, assuming that part of the mortgage is put in the LOC.

  1. How do rates compare on hybrid mortgages compared to straight variable or fixed products? Given that products with “bells and whistles” often come at a premium, people might just be better off making a decision and sticking with it.
    There is always a fairly significant degree of uncertainty regarding future rate movements, especially over the course of the ever popular 5 year term. Going fixed/variable is as much or more about the amount of risk you can absorb anyway. If you can’t take rate shocks, then a fixed is probably for you. If you can, then, IMO, it makes sense to go with the research.
    Al R

  2. Do you a link to the numbers for a 1-year fixed vs. others? What about 2-year fixed and 3-year fixed?

  3. This is a side question. How can anyone trust research that doesn’t include our current type of rate environment in its data sample? There has never been a .25% overnight rate before. Is there not a stronger possibility that variable rates could be more expensive than fixed rates this time around?
    Thank you.

  4. Hi Al: Thanks as always for the feedback. To answer your question, hybrids are typically full-featured mortgages. Their rates are usually 10-20 basis points above no-frills rates. But often they are just as competitive as regular full-featured mortgages. Current rates are an exception to this rule however.
    In many cases a borrower will be a “clear-cut” candidate for either a fixed or a variable. In other cases, the client’s preference or risk tolerance may dictate that 100% fixed or 100% variable are unsuitable. In those situations a hybrid can be a fitting solution.
    Scott: The best variable rate on a hybrid (that I know of) is currently prime – .55%.
    William: The funny thing about models is that they work until they don’t work. The variable-rate research by the likes of Professor Milevsky are of great value to the industry. But Dr. Milevsky would probably be the first to tell you that his study is based on the past, and the future doesn’t always replicate the past in every case. As you point out, short rates have never been so close to zero, and the future re-writes itself every day. While I’d rather bet WITH the research than against it, you still have to look at the cost in a worst case scenario. Some people can’t afford 100% of that cost. They might, for instance, only be able to afford 50% of the downside. This is an example where a hybrid may be a fit.
    Eug: Hi Eug, Just to confirm, which “numbers” did you mean?
    Cheers,
    Rob

  5. By numbers I mean 1-year fixed vs. variable, as well as similar numbers for 2-year fixed and 3-year fixed. Everything I read always talks about 5-year fixed (and sometimes posted 5-year fixed IIRC).
    I know some people lately (including myself) who tend to avoid 5-year fixed these days because of the rate premium.

  6. To put it another way, people keep saying that variable rate mortgages do better than 5-year fixed mortgages 8-9 times out of 10. However, most don’t really talk much about 1, 2, and 3-year fixed rate mortgages. (I’m not considering 4-year fixed since the rates usually aren’t that much better than 5-year fixed.)
    You suggested that 1-year fixed is pretty good in your article, but I’d love to see a link to those numbers if possible, as compared to variable.
    I went with a 3-year fixed this time around. However the next time around my options are going to include 3-year variable, or 1-3 year fixed, or perhaps a hybrid of 3-year fixed and variable if available. I don’t have much time left in my mortgage, but even if I did, I probably would not consider 5-year again. I find the lock-in period rather restrictive, and the rate premium usually isn’t worth it for the rate “guarantee” IMO.
    It’d be nice to have numbers to back up my impression though.

  7. I think Rob nailed it below when he said that while research of this type is necessarily backwards looking, I’d much rather go with research than to guess where rates are going to be over a prolonged period.
    There are upside and downside risks to all rate forecasts right now. While the EU debt crisis likely won’t preclude the BoC from hiking rates, it may moderate the pace at which they hike. And as has been noted on CMT, the spread between variable and fixed rates is very wide at the moment. In other words, there are offsetting factors that, when taken together, do not necessarily translate to “a stronger possibility that variable rates could be more expensive than fixed rates this time around.”
    Al R

  8. Nothing wrong with a hybrid mortgage if it serves one’s indecision. If you cannot afford 50% of the payment increase caused by a hypothetical rate shock you should not be in a variable rate mortgage altogether because your rate expectations could be wrong!
    Fixed rates are certainly better for those whose budget is more sensitive and at current levels are an all-time bargain.
    I went with a variable rate, fixed payment mortgage. In a low interest environment it helps pay down more capital than a fixed rate would, even when rates start to rise.
    Don’t forget it will take an increase of about 2.5% of the BoC overnight rate for variable mortgage rates to match that of current fixed rate mortgage and that should take at least a year and a half. In the meantime variable rate mortgagees are reaping interest savings.

  9. The debate over hybrids, fixed or variable are important to a point but the decision is basically fine tuning in the short term. In the medium and long term we will all be effected by the possibility of a sustained high interest rate environment. The question of type of mortgage needs to be considered in combination with size of mortgage.
    Be prepared

  10. Hi Brian,
    Thanks for the note. The problem with the Manulife One is that you can’t get a discounted variable-rate mortgage with it.
    If you want a hybrid with a fixed and variable rate then you have to pay Manulife’s “Base Rate”, which is prime + .75% (3.00%) currently.
    You could always do part 1-year and part 5-year, but if you’re going to do that you might as well take a National Bank All-in-One. The All-in-One has more flexibility and much lower fixed and variable rates if you use a mortgage planner.
    Cheers,
    Rob

  11. Hi Eug,
    In this environment, a 3-year is a pretty good bet, generally speaking.
    We do the numbers for our clients every day, but it’s pretty time consuming to publish them–due to all the assumptions that have to be explained. Nonetheless, I’ll try to touch on some in our next Term Review, due out shortly.
    Cheers,
    Rob

  12. I don’t think it is about affording payment increases or having indecision. Diversifying interest rate exposure just makes sound sense.
    You would never buy one stock in your retirement portfolio. What makes you think you can outsmart the billion dollar bond market and pick the right interest term?

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