Mortgage Security not That Costly
Posted by admin in mortgage, tags: 60, economy, Minutes, Peley, recession, Scott, U.S.
Forget everything you thought you knew about the benefits of taking a variable-rate mortgage instead of locking in for the long term.
A new study suggests the security of a five-year mortgage costs little or nothing beyond a riskier variable-rate mortgage, providing you get a jumbo-sized rate discount.
“Interest costs on discounted closed five-year mortgages have been close to, and often lower than, those of variable-rate mortgages since late 1996,” senior Canada Mortgage and Housing Corp. economist Ali Manouchehri writes in the study.
Homeowners have made variable-rate mortgages hugely popular in the past few years in the belief that you can save on interest costs by pegging your mortgage rate to your lender’s prime lending rate. As the prime rises, or as has generally happened in the past few years, fallen, so goes your mortgage rate.
The prime rate at the major banks is now 4.5 per cent, while the posted five-year rate at the big banks is 6.15 per cent. In just one year, the variable-rate choice would save you about $1,700 on monthly payments toward a $150,000 mortgage amortized over 25 years (assuming a level prime rate).
Historically, you would also have saved a lot. The CMHC study shows that five-year mortgages taken out from 1993 through 1998 would have cost anywhere from $50,000 to $5,000 in additional interest paid over the term of the loan (the example is based on a $100,000 mortgage amortized over 25 years).
The flaw with this analysis is that it doesn’t reflect real-world mortgage pricing. These days, very few people take out a mortgage without a sizable discount off the posted rates at major banks.
For that reason, the CMHC’s Mr. Manouchehri decided to compare discounted five-year mortgages with discounted variable-rate mortgages. Incidentally, five years is the most popular term by far for fixed-rate mortgages at about 59 per cent of the total.
The size of the discounts Mr. Manouchehri applied was based on the difference between posted major bank rates and the best deals available from other lenders. For five-year mortgages, he used a discount of 1.25 of a percentage point; for variable-rate mortgages, it was 0.4 of a point off prime.
For five-year mortgages taken out between 1993 and mid-1996, the five-year mortgage was costlier in terms of interest costs. Since then, however, variable-rate mortgages have generally been a little bit more expensive.
Obviously, there’s nothing in this study that decides the fixed-rate versus variable-rate debate once and for all.
In fact, the CMHC study may just confuse anyone who recalls some research done for Manulife Financial back in 2000 by York University finance professor Moshe Milevsky. His research found that the extra interest charged on a five-year mortgage would have cost $20,000 on average between 1950 and 2000 for a $100,000 mortgage amortized over 15 years.
To make some sense of the variable-rate versus five-year question, let’s go back to the CMHC study.
It shows that five-year mortgages, discounted or otherwise, were especially bad choices for a three-year period starting in mid-1993. Rates were high for a while back then, but they subsequently fell.
You were a spectator to these rate declines if you were stuck in a five-year mortgage, while people in variable-rate mortgages would have benefited almost immediately.
It’s a different world now, though. Five-year mortgage rates are close to a 50-year low, which suggests they’re far more likely to rise over their term than fall.
So what’s the best choice here, variable-rate or five-year fixed rate? People who want to pay rock-bottom mortgage rates for as long as possible will probably still want a variable-rate mortgage. Remember, you can lock this sort of mortgage into a fixed term without penalty in most cases.
The case for the five-year term looks almost as strong, though. First, the CMHC study tells us there may not be a significant cost to locking your mortgage in for five years, and you might even save a little over a variable-rate mortgage.
Second, the likelihood of higher rates in the years to come would suggest that this is a good time to lock in.
If you had a variable-rate mortgage discounted to 4 per cent, the prime would have to go up by 0.85 of a percentage point to equal the current five-year rate. That’s not a lot of ground to cover in the span of 12 to 18 months when the economy is doing well.
Arguably, the variable-rate versus fixed-rate debate is all about risks and rewards. Right now, the five-year option offers much less risk, and almost as much reward.
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Help answer the question about Mortgage
How much mortgage debt is there in the USA?Given all the worries about credit in this country, and subprime mortgages, I was curious as to what the entire amount of home mortgage debt is. There are about 110 million households in the country, with 70% of them owned residences. Let's say there are 75 million owned homes. Not all have mortgages, but if 70 million do, and the average mortgage amount on such homes is $200,000, that comes out to a scary $14 TRILLION of mortgage debt in the USA. If just 2% default, the amount of bad home loans is $280 billion. It could obviously be much higher.
Does anyone know what total mortgage debt is per household and in total? This is a real problem that could damage the economy.
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nawkrm ……bud, that’s exactly what has been happening in Australia here, in Queensland they were called the ‘RENO KINGS’…..they buy a house that needs work, cheap as!… very cheap and tacky fittings and even used secondhand fixtures, sold it at a silly price within 1 to 3 months and people fell for it. Then there are the people with property portfolio’s, there to blame as well. From what I am hearing those people are becoming very worried.
more false BS–actually ACORN along with congress forced lenders to give credit to people with poor credit–and banks got greedy and did what they asked. That coupled with poor financial awareness of the borrower not reading thier loan documents caused the problem..