|
BMO released a report on Friday about
choosing between fixed and variable-rate mortgages.
BMO says, “Over the past 30 years it has been more
cost-effective for borrowers to have a variable-rate mortgage 82% of the time.”
That appears true according to BMO’s assumptions.
We did a slightly different test, though, and will talk about that in a moment.
There is a problem with these types of studies,
however, and that is sample size. There have been very few cases where history
resembles today. In fact, we’ve never been witness to a monetary policy rate
near 0%.
Nonetheless, BMO economist, Doug Porter, had this
to say in support of variable rates:
- “The current outlook for
inflation remains benign, which will likely keep price pressures at bay
well into 2011.”
- The difference between
5-year fixed mortgage rates and variable rates “is now close to an
all-time high.”
- “There is also some risk
to locking in as fixed rates could fall if the economy performs worse than
anticipated.”
On the other hand, BMO’s report made several points
upholding fixed rates. It said:
- "Short-term rates
are at extreme lows and pressure is likely to build for higher rates in
the year ahead."
- “The Bank of Canada's
overnight rate is now as low as it can go, so there is no further downside
for variable rates.”
- “Although inflation
hasn't been a problem since 1991, there is a risk of an inflation flare-up
as global central banks keep the pedal to the policy metal, and amid
record government deficits. The Bank of Canada could be forced to raise
interest rates aggressively, driving variable mortgage rates higher, but
leaving Canadians with fixed rates unscathed.”
- Fixed rates were
beneficial twice in recent history… “through the late 1970s and briefly in
the late 1980s.” Both cases were “ahead of a period of rising interest rates,
as is the case now.”
That last point is where you can look at things in
two ways. BMO arrived at its conclusions by comparing posted rates to prime rate (their chosen proxies for fixed and
variable mortgage rates). Prime is a good approximation for variable
rates but no one pays posted fixed rates anymore.
So we did the same study using discounted fixed
rates (i.e., 1.5% off of posted, which seems reasonable). The results
were very different…
With these assumptions, there were at least six
periods in recent history when fixed rates beat variable rates at prime.
Put another way, discounted fixed rates would have outperformed prime rate
almost half the time. (Mind you, if big discounts to prime were available
once again, variable rates would fare better.)
BMO declares that the optimal choice “depends on
the individual.” That, of course, is true as always.
Interestingly, if we forget about chart data for a
moment, it appears BMO presents more arguments in support of fixed rates than
it does for variable rates. In addition to its comments above, BMO says:
- “The moderate extra cost
of peace of mind you can get from a fixed rate may be a price worth
paying.”
- “There is also a
reasonable scenario where fixed rates may actually prove to be a cheaper
alternative at this point.”
Despite all of this, BMO says it’s “core view” is
that:
“The most likely economic and interest rate outlook
will ultimately again slightly favour the variable rate option.”
But what does “slightly favour” mean? If we
assume a 55% probability, then it’s little better than a coin flip.
For most people, if they faced a 45% probability of
losing money, they’d insure against it. Fixed rates provide such insurance,
and if rates rise 2.5% or more over the next few years, that insurance will
start looking pretty good.
Our perspective isn’t meant to be a blanket
endorsement of fixed rates, but the above is definitely something to think
about if you’re on the fence.
|
