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The RBC RateCapper Mortgage

RBC68% of Canadians choose fixed-rate mortgages. Yet, most people would consider a variable-rate mortgage…if it weren’t for the darned payment risk.

RBC feels it has an ideal solution.  It’s called the RateCapper mortgage.

“RateCapper gives homeowners the best of both worlds,” says Marcia Moffat, VP, home equity financing.  “They can take advantage of a low prime rate, while at the same time locking in a guarantee they will never pay more than the ‘capped rate’ over the term of the mortgage, no matter how much the prime rate may rise.”

That “capped rate” is 5.85% at the moment.  However, RateCapper borrowers start off by paying just 2.25%.  Therefore, 3.60% is the most their rate can go up.

RBC has offered the RateCapper before. It originally launched way back in 1993.  Moffat says it came out of hibernation because RBC has “seen increased demand for mortgage options that provide additional rate protection.”

RBC executive, Anjel Van Damme, told FP’s Garry Marr today:  “It’s the best product in a rising-rate environment for consumers who can’t choose between fixed and variable.” (FP Story)

Claims like these always pique our interest, so we ran a few numbers.

First off, it’s worth noting that prime rate has averaged 4.81% over the last 10 years, and 5.85% since 1991.  1991 is when the Bank of Canada started inflation targeting and knocking down long-term interest rates.

If you assume that prime will jump back to its 1991-2010 average (not our prediction, just an assumption), it would take a 3.60 percentage point jump to get there from today’s rate.

So let’s assume prime goes up even more than that:  four full percentage points.

That would take prime rate from 2.25% today to 6.25% by July 2012.

In that case, a regular prime – .50% variable would still be cheaper over five years than the RateCapper, by over $1,300 per $100,000 of mortgage.

Keep in mind, a 4% hike is well above the forecasts of most economists.  If you really believe rates could go that high, a long-term fixed rate is a better bet. Given the same 4% rate hike assumption, a 4.35% five-year fixed–for example–would save you over $3,700 per $100,000 of mortgage, compared to the RateCapper.

If you want yet another alternative, consider a hybrid mortgage.  Hybrids are part fixed rate and part variable rate.  They’re meant to diversify your interest rate exposure—meaning they give you a chance to save interest while covering part of your backside.

As for the RateCapper, it’s a great idea at first glance. But in our view, RBC has set it’s 5.85% cap too high to be mathematically compelling.

More on the above analysis…

All scenarios above are hypothetical and approximate and assume a 25-year amortization, a 5-year term, and a 1/4 point rate increase at each BoC meeting starting this July (until rates rise 4%).

In reality, the BoC will likely pause its rate hikes at some point, and/or occasionally hike in increments other than 1/4 point.  Nonetheless, a linear 1/4-point-per-meeting rate hike assumption is reasonable for modeling purposes and doesn’t invalidate the conclusions.

As always, speak with a mortgage professional to confirm which mortgage options make the most sense for you.