If you own a home or are considering buying a home, would you choose a fixed or variable-rate mortgage? Not sure? Join the club.
The question of fixed or variable rates has many homeowners wringing their hands right now. The economy is in recession, although many experts are seeing signs of recovery. The federal government is doing its part to help the economy with its various stimulus packages, but the unemployment rate is still very high. In short, things are still a little unstable.
What does all of this mean for the future of mortgage rates? Is it foolish to lock in to a fixed rate with interest rates being so low? Will some unforeseen economic factor cause a sudden spike in interest rates, making a variable-rate mortgage too risky?
It would be nice to have a crystal ball to answer all of those questions. Instead, we’ll have to rely on some educated guessing by the experts. Let’s start by looking at the way mortgage rates are calculated so we know what factors might affect rates in the near future.
Calculating Mortgage Rates
To most non-bankers, mortgage rates are a bit of a mystery. There are basically two kinds of rates used in mortgages – fixed and variable.
Variable rates are tied to the prime rate, which is set by the Bank of Canada. Lenders take prime and add a surcharge to determine your mortgage rate. At this point in time, prime is sitting at 2.25%, with lenders charging about +0.4%, for a mortgage rate of 2.65%. Because the prime rate can fluctuate, variable mortgage rates are also subject to changes throughout the term of the mortgage.
Fixed rates are tied to the bond market. A June, 2009 Toronto Star article provided a good explanation of how this works. Banks use the bond market to finance their mortgages because they lend out more than they take in through deposits. When the costs of borrowing on the bond market increase, so do fixed mortgage rates. As we will see below, this is the situation we are in right now.
Current Economic Changes and The Effect on Mortgages
Banks have recently begun increasing fixed mortgage rates because it is costing them more money to borrow on the bond market. According to the Toronto Star, there are a couple of reasons for these higher costs: the bond market is beginning to “price in the prospect of an economic recovery” in late 2009 or early 2010; the bond market is also worried about inflation resulting from the large economic stimulus packages that governments around the world have issued.
The risk of inflation may be affecting the bond market, which will, in turn, drive up the rates for fixed-rate mortgages. But actual increases in the inflation rate – if they occur – can also affect variable-rate mortgages. If the rate of inflation rises, the Bank of Canada may decide to increase interest rates to cool spending. In that case, variable-rate mortgage costs will increase in lock step with increases to the prime rate.
The potential risk of inflation is something that all homeowners should watch for. It will affect their mortgage, whether it is a fixed or variable rate. Pay attention to what the experts are saying about current economic indicators and especially the rate of inflation. And consult with a mortgage professional to determine whether now is the time to lock in to a fixed rate to hedge your bets against potential spikes in the rate of inflation.
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For information on acquiring a home equity loan in Toronto or a Canadian mortgage speak with a professional at Canadian Mortgages Inc.