Analysts predict more increases, thousands in losses compared to fixed-term holders
Michael Kane and Eric Beauchesne
Sun
Homeownership is more expensive today for buyers, and for owners with floating rate mortgages, and will become even more costly in the months to come as the Bank of Canada raised its trendsetting rate another quarter point Tuesday.
How much more expensive depends on how high interest rates go, but with some analysts predicting they will rise another 1.5 points, homeowners could be paying thousands of dollars more a year.
Rising interest rates mean home buyers with variable rate mortgages could lose thousands of dollars over the next few years compared to those with fixed-term loans.
The big unknowns are how high interest rates will go and how long will they stay there. Historically, variable rate mortgages, which rise and fall with interest rates, work out cheaper over the long term than locking in for a fixed rate every five years.
Most commentators expect another quarter point hike by the Bank of Canada in December but there is less certainty about what will happen after that.
A TD Economics forecast published Tuesday calls for rates to rise another full percentage point by mid-2006, beginning a gradual downward slide thereafter.
In the TD scenario, borrowers with a typical 4.0 per cent variable rate mortgage (three-quarters of a point below bank prime) would break even with borrowers opting for today’s best widely available five-year fixed term at 4.5 per cent. After that, the floating rate borrower would gain ground.
But if rates jump 1.5 per cent over the next six months, and then stay up for the balance of five years, the variable borrower with a $175,000 mortgage would be out more than $8,000, says Karl Madsen, regional sales manager for Invis mortgage brokers. That is, the variable rate borrower would owe $161,958 after five years, compared to the fixed-term borrower’s outstanding balance of $153,644.
The loss climbs to more than $16,000 on a $350,000 mortgage and nearly $24,000 on a $500,000 loan.
And if rates really took off, climbing an additional 4.5 per cent over the next 18 months, losses would be magnified to $31,000, $62,0000, and $89,000 respectively.
Assuming monthly payments remain unchanged, the losses are reflected as higher outstanding loan amounts at the end of five years. In reality, variable rate borrowers under the second scenario would face payment increases to prevent them owing more than their initial loan at the end of five years.
Madsen says, however, it is probably unrealistic to assume that rates would stay at those elevated levels.
“Once the Bank of Canada determines that higher rates are slowing the economy and inflation risks are subsiding, there is a good chance that rates could begin to fall again,” he said.
“The variable could still be a good option, depending on when and by how much the rates might come down again.”
The Bank of Canada, in announcing it was raising its overnight target lending rate for the second time this year to three per cent from 2.75, said that because the “economy now appears to be operating at capacity, some further reduction of monetary stimulus will be required to … to keep inflation on target.”
The bank reiterated inflation will rise to three per cent, a full point above its two per cent target.
With soaring energy prices and global trade and currency imbalances, however, it added there are also risks that global economy, and in turn Canada’s, will be weaker than expected, which it suggested would limit future rate hikes.
North Vancouver mortgage broker John Ribalkin said he was “swamped” Tuesday by borrowers alarmed by the rising rate trend. He was telling them to file applications for fixed-rate mortgages as soon as possible.
“When you have an application in, you’ve got the lender committed. You then have a 90 to 120-day window, depending on the lender, to make your final decision,” said Ribalkin of The Nova Team at Mortgage Intelligence.
“If you delay an application, you could find the barn door closed on today’s fixed rates.”
As recently as last May, he said borrowers were split 50-50 between the variable and fixed rate options.
“We’re hardly doing any variables now,” Ribalkin said Tuesday. “People are choosing security.”
Across the B.C. market, borrowing trends are little changed with about 75-80 per cent choosing a fixed term and 20-25 per cent going variable, said Kevin Clark, regional vice-president of Mortgage Intelligence.
“It depends on your comfort level over the long term,” Clark said. “If you lose sleep and you are watching interest rates daily, and it’s that tight on the budget, then always the recommendation is to secure it for a period of time.”
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IF RATES SHOOT UP:
Here’s a scenario for a 4% variable mortgage if rates rise another 1.5 points over the next six months.
$350,000: Mortgage
$1,937.14: Payment*
$323,916: Balance after 5 years
$16,628: Loss.
*25-year amortization
Source: Invis
© The Vancouver Sun 2005
