TORONTO, ONTARIO--(Marketwire - March 23, 2012) - According to a new report penned by Douglas Porter, Deputy Chief Economist, BMO Capital Markets, and Benjamin Reitzes, Senior Economist, BMO Capital Markets, financial stability for Canadian homeowners in the coming years will be supported by locking-in and opting for shortened amortization periods.
The report notes that over the past few years, BMO Economics has supported choosing variable rates. However, the view has changed based on current offers on long-term mortgage rates and interest rate increases expected over the next two years.
"Our interest rate outlook now projects that fixed mortgage rates will trump variable. While the decision ultimately depends on the individual, the low rate combined with a shorter 25-year amortization will significantly strengthen household financial stability," said Mr. Porter. "For those who are without financial flexibility and would run into difficulty from a pronounced upswing in interest rates, the potential extra cost for the protection of household finances now appears to be a price well worth paying."
Mr. Porter added that low interest rates may not last as long as many had previously expected, giving a significant advantage to choosing a fixed rate. "The bond market, in particular, is sending loud warning signals that the era of low interest rates may finally be drawing to a close. So, even if variable rates take some time to climb, we may not see such low fixed rates again any time soon."
"With the chance of rate hikes in Canada at some point over the next two years increasing, there are a number of reasons to believe that the fixed rate option will be the hands-down winner," said Mr. Porter.
The Case for Fixing
A conventional fixed rate mortgage can mitigate a number of risks. While inflation hasn't been a big issue in Canada - averaging 2 per cent since 1991 - there is the risk of a flare-up at some point down the road. This could force the Bank of Canada to raise interest rates aggressively, leaving fixed-rate borrowers unscathed. Additionally, short-term rates are already extremely low. Considering the likely upward trend in interest rates as the global recovery picks up speed in 2012, this increasingly looks to be one of those rare periods when a fixed rate turns out to be the superior choice. Finally, a borrower gets certainty with fixed rates, and that certainty is worth something to many. The small premium on fixed-rate mortgages and shorter amortization schedule represents inexpensive protection against rising rates.
The Case for Staying Variable
The clearest advantage to a variable rate mortgage is that it has been consistently less costly than its conventional counterpart over time, with only a handful of occasions in modern history when a variable rate was the less favourable option. Tame inflation, taken with a moderate global growth outlook and the Federal Reserve committing to exceptionally low U.S. rates well into 2014, point to the Bank of Canada keeping rates steady for some time yet. Plus one can always lock into a fixed rate at a later date-although there is no guarantee that future longer-term rates will be anywhere close to as favourable as BMO's 5-year offer of 2.99 per cent.
The verdict: The decision still depends on the individual. But, for those who have limited financial flexibility and would run into difficulty from a pronounced upswing in interest rates, the potential extra cost for peace of mind now appears to be a price well worth paying. Given historically low long-term rates, and the fact that central bankers are becoming more upbeat on the growth outlook, the fixed-rate option now looks extremely attractive.
Katie Archdekin, Head of Mortgage Products, BMO Bank of Montreal, suggests that regardless of whether homebuyers choose a fixed or variable rate, opting for a shorter amortization period provides significant benefits. "Shortening the amount of time you carry mortgage debt should be a priority for any homeowner, as it saves thousands of dollars in interest rates over the life of the mortgage and ensures Canadians can begin building equity in their home sooner."
Currently, BMO offers a new 10-year mortgage at a great introductory rate of 3.99 per cent with a maximum 25-year amortization. It is modeled after the popular 5-year maximum 25-year amortization mortgage at 2.99 per cent. Both are available to new and existing customers; the offers are available until March 28, 2012.
The full report can be downloaded at http://bmonesbittburns.com/economics/reports/20120323/sr120323.pdf.