Uptrending Rates Aren’t Time to Gamble

Take a peek at the recent trend in this chart.


(Chart source: MarketWatch)

It’s a graph of the 5-year government bond yield—the guiding force behind long-term fixed mortgage rates.

On Wednesday, the 5-year bond ended the day at 1.89%—the highest close in over two years. If you were a trend follower, you wouldn’t bet against rates moving higher from here. But many people are.

The folks I’m talking about are fixed-rate mortgage shoppers with renewals or purchases closing in 5-9 weeks.

These people have a choice. They can:

  (a)  Lock into a 45- to 120-day rate hold now, or

(b)  Wait until they’re within 30 days of closing. That’s when many lenders feature “quick close” specials, typically their best pricing.

(There are exceptions. A few lenders offer quick closes with up to 60-day holds, but those rates are currently higher than today’s best 30-day rates. Occasionally you’ll find the best deals with 90- to 120-day holds, but they’re usually at regional lenders with smaller lending areas.)

Quick close rates are generally lower because lenders’ hedging costs aren’t as high. In fact, 30-day rates can be 10-20+ basis points better than long-term rate holds.

Interest Percent Sign on Dice Signs Gamble for Best RateBut waiting for a better deal is a dice roll because rates can climb in the meantime. In fact, it happens about half the time based on simple probability.

So is it really worth the gamble—risking an unknown rate jump to save one or two-tenths of a percent?

Folks should assume that the odds of rates increasing are at least 50%. If the chance of a rate drop is the same, one can expect no mathematical edge by waiting for better rates. Instead, someone can secure a rate today, eliminate all upside risk and benefit from a rate drop if rates fall before closing.

Timing the market is seldom astute, and with uptrending rates that’s arguably even truer.

Sidebar:  Over the last 10 years, the 5-year government bond yield has averaged 2.94%, more than 100 basis points higher than today.

Rob McLister, CMT

  1. With the world more in debt than ever before (well, ok… US consumers almost 20% less in debt than in 2008, but their government being about 50% more in debt) how can anyone think that higher interest rates are sustainable? For example, the Canadian Federal Government has not reached its deficit goals with current interest rates, if interest rates go up, based on current policy, further cuts would be made to reduce the deficit which will negatively impact the overall economy. And don’t forget about the overleveraged Canadian consumer…
    There may be a few point increases in the future, but overall, we are following Japan, where they’ve had 20+ years of extremely low interest rates.

  2. It is the lenders who control the rates, not the borrowers.
    In Japan, there is a huge pool of domestic yen savings widely held dispersed among the citizens, and that has facilitated their lower rates for the past two years.
    If you think that bond rates won’t increase because Gov’ts “can’t afford it”, I would caution you.

  3. Although you are right, most of the Japanese bonds are owned domestically, in my opinion, they have the same problems that we (as in the Western world) do: their bonds are “highest rated” collateral for the banks and any increases in interest rates would decrease the value of the bonds, which would result in a shortage of liquidity. Their central bank has been trying QE for almost 20 years, and although their latest attempt seemed to jump start inflation, it looks like that is dying off too and they are slowly going back to their old deflationary ways.
    Again, in the short term (6 months – 1 year) interest rates may go up, but long term (5 to 10 years), we are “stuck” in 1-2% range.
    Just to end on a “happy” note – do you think the world’s economy is in a better place than 2008 to warrant higher interest rates? Europe is a mess, China is slowing its growth, other emerging economies are slowing down too, US growth is based on part-time jobs and de novo money creation, Japan is aging… I don’t know about you but I am pretty skeptical. Hopefully the new iPhone and Hyperloop will kickstart the economy.

  4. Nice logical reply, without trying to micro manage these ongoing yield fluctuations. But unfortunately many clients focus on the immediate situation instead of considering a more long term holistic approach….

  5. We are not as influential as the US/Japan to keep rates low as that could still result in market revolt as bond prices go up and/or our dollar devalues (higher inflation). Canada’s debt in the 80’s/90’s had interest payments being 2-3x higher then they are today given the higher rates back then, plus past debt is maturing and being re-issued at much lower rates. The main focus is what central banks are plannig to do and if they will be the only one left buying bonds (US fed already buys 90% of theirs and Canada’s similar QE program has never been this large with a 50% y/y volume increase in 2013)

  6. Lets say we knew that rates would rise 1 percent and stay there. Based on interest alone, what would be the right term to pick?

  7. That is not enough info to answer.
    In your scenario, when do rates increase 1%?
    What rates are increasing? Variable rates? Fixed rates?
    How long do you need a mortgage for?

  8. All that matters is when you take whatever rate or term to be happy with it, to know exactly how much interest you’ll pay and how much will cost you to break it if needed.
    Everything else is mostly an educated (or un-) gamble.

  9. Hi Canadian,
    Thanks for the note. A few related thoughts…
    Being happy with a mortgage is typically synonymous with minimizing risk and borrowing cost, not just over one term, but over the life of the mortgage. For most people, it helps to have a long-term mortgage strategy that reduces breakage costs and renewal risk and meets future borrowing needs.
    Unfortunately, we can seldom know exactly how much interest we’ll pay over a term, let alone over our amortization. Mid-term mortgage changes, future rates, uncertain termination costs and other unknowns can make exact projections impossible.
    We can however attempt to minimize risks and costs through proper planning, which may entail scenario analysis (e.g., what happens to me if I take ‘X’ term and rates do ‘Y’), basic personal assessments (e.g., picking a term that factors in employment risks, income type, personal obligations, etc.) mortgage comparisons (of more than just a few lender’s products), and other techniques.
    Much in life is a gamble. The goal is to move the odds more in our favour, and that takes a bit of thought and planning.

  10. Alex – brilliant points and well said. Simply put, with the US government at $17 trillion in debt (and counting) each 1% rise in interest rates costs them an extra $170 bn/yr in expenses – do we really think their budget can handle that? No way!
    So the way of Japan is the only way forward – as the debt mountain grows higher and higher, the only way to maintain the same interest outlay expense is for rates to go lower and lower.
    Canada is mainly along for the ride, though provinces such as Ontario and Quebec definitely need rates to remain very low in order for their finances to be sustainable … and provincial yields are just a spread over Canada government bond yields.

  11. Ugh – This is exactly the boat we are in!
    (P.S. Thanks for the post! Helpful for us newbies.)
    We had a great variable mortgage that is up for renewal in 2.5 months. We were debating if a 10-year fixed rate @ 3.89% would be a good idea. Based on some of the comments a variable might still be a solid way to go.
    Food for thought… Thanks again!

  12. I watch Bank of Canada rate changes closely. I have a variable rate credit margin-type mortgage at a bit more than 3%. When does it makes sense, if ever, to lock it in?

  13. Lock in if you’re worried you can’t make higher payments.
    Guessing what rates will do is pointless.

  14. not really worried if I will be able to make higher payments…but would rather not –if it can be helped.(money not spent on mortgage payments is money that can be spent in more enjoyable ways) No ?

  15. Most comments assume the same type of environment as the past 10 years in Canada….most borrowers have never experienced a rising rate trend. Does it make sense that the house I sold 10 years ago $180,000 is now worth $550,000?
    Government debt, pension funds deficits, real estate bubble, etc….maybe more difficult times are coming ahead in Canada….

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