One of life’s simpler rules is to closely watch what others do, and do the opposite.
Most people freaked in 2009, sold their mutual funds in a panic at firesale levels and ran screaming into the void. Most people buy things because they’re popular, which makes then rise in value. (They’re popular because they are, well, rising in value.) Most people want houses when markets are hot, then shun them when prices and sales fall. People lined up in the lobby of my bank tower to buy gold at $1,900 an ounce. Today bullion’s $1,200. No line. Most people have borrowed a lot and saved little. Most people are financial cripples, though knowledge is but a click away.
And most people are locking in their mortgages. Eighty per cent, in fact. Not smart.
Despite Friday’s middling job numbers in Canada, the economy’s a sloth. Exports are down, layoffs are up and we’re more a country that builds condos than manufactures stuff. Growth is subpar, and the Bank of Canada has stopped warning people about rising interest rates. As I told you a few days ago, it’s way more fussed over an inflation rate on its way to zero.
As a result, the central bank will keep its key rate sitting where it is – in the ditch – until 2015. That doesn’t mean long, fixed-rate mortgage rates won’t jump (they will, in late March) because those are set in the bond market. But it does mean VRMs – variable rate mortgages – will be dirt cheap for another two years.
So why would you borrow money at 3.79% at BeeMo or Scotia when the same bank will give you a floating rate of around 2.5%? Why wouldn’t smart homeowners invest the extra money, get a bit of growth, and chunk it against the principal when the loan comes up for renewal?
Because most people think with their duodenums. Bankers and mortgage brokers, with a vested interest in promoting fixed-rate loans (more revenue and commission), have scared the poop out of folks, convincing most they’ll be ‘safe’ if they lock in. As a consequence, given current conditions, these poor sods collectively will be shelling out millions more a year than they have to in interest.
Yes, the rate on a VRM can increase (and will, eventually). That means although your monthly payment remains fixed, more of it would go towards interest and less to paying off the debt with each move higher. But so what? Variable rate mortgages are almost always convertible. That means if you read a pathetic blog written by a bearded god, for example, and learn a rate increase is imminent, you can always convert to a fixed loan with one phone call.
In other words, why aren’t 80% of borrowers saving themselves thousands of dollars a year by riding with a variable rate that’s a full 1% less than the five-year toll, when they have built-in protection from spiking rates? Do they enjoy paying too much? Do they covet TNL@TB?
Nope. Just emotional. Fear’s the great motivator. So most people would rather avoid paying more for their mortgages if rates happen to rise in a few years than pay more now for a few years with a higher rate. (That sentence actually makes sense. Trust me.)
Lesson: go variable. Unless, of course, you are a deflowering virgin and can’t afford it.
Little-known but most real is the Bank of Canada ‘benchmark rate.’ This sucker is struck at 12:01 am ET each Monday, and becomes the official qualifying rate for that week for borrowers who don’t have a 20% down payment.
These are the people who must purchase CMHC mortgage insurance (insuring the lender, not them, against default) in order to secure a loan because they’re high-ratio borrowers. Regardless of the great rate the bank may be offering (like 2.5% for a VRM), if these people choose a mortgage term of less than five years, or any variable mortgage, they must qualify to make payments at the benchmark rate, not the bank’s offered rate.
And what’s the benchmark rate today? A big 5.34%. It last increased (by a fifth of a point) at the end of August, is more than double the current VRM. Yikes.
For example, a buyer qualified for a regular, discounted 5-year mortgage at 3.49% with a maximum purchase price of $300,000 would have to requalify at 5.34% if she wanted to switch to a variable-rate loan (even though the payments would be less). The result? The maximum purchase price would then fall to $250,000.
The intent of this change (made by that crafty little F, Rob Ford’s former best friend) was to throw a new obstacle in the way of first-time buyers, to ensure they could withstand inevitable rate increases. But it didn’t work. They all locked into five-year mortgages to avoid the benchmark rate, which means they pay more than they have to, can’t save, and become more financially vulnerable – which is why they only had 5% down in the first place.
This is called government. Watch it closely. Do the opposite.