Fixed replaces variable as favoured mortgage

BMO economist says now's the time to lock in as spread narrows between the two rates

As the federal government warned it may again tighten mortgage rules, a Bank of Montreal economist says fixed mortgages "clearly trump" variable mortgages in today's economy.

There are two reasons for the change of heart by Douglas Porter, deputy chief economist at BMO: the intense com-petition among lenders and the economic recovery in the U.S.

"While we have in the past supported going variable, and even though short-term rates are likely to remain low this year, current offers on long-term mortgage rates and the recent shift in bond market sentiment tilt the balance heavily in favour of locking in at this stage," wrote Porter in a report, Time to Say Goodbye to Variable.

The report coincides with BMO offering two low-rate mortgage options, a 2.99 five-year rate and a 3.99 10-year rate, both of which are limited to 25-year amortization and limited prepayment options. Many other lenders have followed suit, offering low-rate mortgages, sometimes with more flexibility.

Porter said in his report that historically, 84 per cent of the time since 1975, borrowers with variable rates saved money over those who took fixed rate mortgages. The late-'70s were the exception, with higher variable rates than fixed rates, followed by skyrocketing interest rates in the early 1980s. When asked if he is predicting some-thing similar might happen in the coming years, Porter said, "No, but there might be a very pale imitation of that."

In Vancouver, because real estate prices are so high, a fixed-rate mortgage can help people sleep at night, said Jennifer Muench, BMO's vice-president of personal banking in Vancouver.

"When you go from variable to fixed, what it really does is give you peace of mind," she said. "If you are in a situation where you have high costs for your mortgage payments, knowing exactly what your payments will be over a five or 10-year period is huge."

Banks have also reduced the discount offered on variable rates in recent months, which means variable and fixed rates are very similar. Porter said it's "next to impossible to predict" what will happen with those discounts if and when interest rates go up.

The Bank of Canada is unlikely to raise rates until next year, Porter said, but added he expects the overnight rate, which is one per cent now, to rise to about four per cent within four years.

Meanwhile, the federal government, dealing with signs of an overheated property market, is ready to tighten mortgage insurance rules again if necessary, Finance Minister Jim Flaherty said Thursday.

Flaherty also chided bank executives for asking the government to impose more restrictions, noting the banks are the entities that offer mortgages.

Canada's banking regulator, trying to curb risks posed by record-high levels of household debt, said this week it wanted lenders to be more trans-parent about their mortgage businesses.

Flaherty has imposed tougher requirements for government-backed mortgages three times since 2008.

"With respect to tightening up the mortgage insurance market we've done it three times ... and we watch, we monitor the market, and if we have to tighten it some more we will," he told reporters.

"The new housing market produces a lot of jobs in Canada so there's a balance that needs to be addressed. I'd like the market to correct itself, quite frankly, if it can."

Since 2008, Flaherty has lowered the maximum amortization period for new mortgages to 30 years from 40 years, raised minimum down payments required to qualify for government insurance, and required all borrowers to qualify for a five-year fixed-rate mortgage to get insurance.

Statistics Canada is set to release a fresh report on house-hold indebtedness on Friday, while recent reports show that Canadians continue to pile on more debt, surpassing levels reached in the United States before the financial crisis of 2008.

The risk, says Queen's University finance professor Louis Gagnon, is that a sudden rate shock will send the housing market into sharp retreat and drag the Canadian economy down with it.

"If we keep going this way and there's an interest rate shock, the larger the shock, the larger the number of homeowners that will be put in a tight spot and have to sell their homes in a market that has become illiquid because other people are doing the same thing," he said.


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