It’s been three weeks since the twin debt crises in the U.S. and Europe started hammering bond yields lower.
The Big 6 banks have still not passed along this cost savings by lowering advertised rates. (Lenders’ cost of funding fixed-rate mortgages typically drops as bond yields drop.)
Behind the scenes, however, discretionary fixed rates continue to fall. If you’re well-qualified and shopping around, you’ll find full-featured mortgage rates at or under:
3.49% for a 5-year fixed
3.00% for a 4-year fixed
2.80% for a 3-year fixed
2.60% for a 2-year fixed
2.59% for a 1-year fixed
2.15% for a 5-year variable
For a financially secure borrower who doesn’t plan to break his/her mortgage within 4-5 years, two terms are now in the value zone (i.e. they have the lowest implied interest cost):
The 5-year variable
The 4-year fixed.
The ideal mortgage depends, among other things, on your financial circumstances (see I.D.E.A.S.) and on global economic performance. The latter unfortunately can’t be known in advance, but you may nonetheless have opinions on it.
If you believe, for example, that the current economic slowdown and/or European debt crisis will worsen considerably, that thinking would be consistent with the Bank of Canada raising rates cautiously over the next five years (perhaps two hikes in mid-2012, a 12 month pause, and 100 bps of further tightening thereafter). Even a rate cut can’t be ruled out in this scenario.
In this sample case, our rate simulations find that a variable at 2.15% would offer the lowest hypothetical borrowing cost.
If instead, you expect the economy to rebound and inflation to make a comeback, and you think Europe will effectively resolve its sovereign debt challenges, then that would suggest a more aggressive Bank of Canada response (perhaps three hikes in mid-2012, a 12-month pause, followed by 125 bps of additional tightening).
In that scenario, a 4-year fixed at 2.99% would be least costly. In year five (when the 4-year term matures), you could renew into a 1-year fixed, variable, or whatever the best value happens to be at the time.
Naturally, the above are just two of infinite scenarios that could play out over the next five years. Nonetheless, if you fiddle around with the assumptions slightly, the odds are still good that one of these two terms will yield the lowest total interest cost over the next five years. That’s why they’re among the best values in the market…as of today anyhow.
Sidebar: The rate simulations discussed above compare amortization tables for every term, and series of terms, over a similar 60-month period.
(A “series of terms” refers to two or more terms back-to-back. This includes cases where a borrower might get a 2-year fixed, for example, and then renew into a 3-year fixed.)
The simulations are based on deeply discounted rates, historical mortgage spreads (used for determining projected renewal rates) and on the above two rate scenarios (which we’ve adapted from recent Big 6 economist commentary).
Once a simulation is run, its amortization tables are then examined to see which term, or series of terms, entails the least interest expense over five years.
Results here should not be deemed a recommendation and projections are subject to change. It’s important to remember that there are economic events which no one can foresee. Those events often change the course of rates radically. Always speak with a licensed mortgage professional for advice suitable to your circumstances.
Rob McLister, CMT
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