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Historical 5 Year and 10 Year Fixed Mortgage Rates - What you really need to know

2012-01-17 | 23:06:12

Historical 5 Year and 10 Year Fixed Mortgage Rates - What You Really Need to Know

What a week for mortgage rates! My email inbox has been filled with inquires about the 5 year fixed rates at 2.99% and 10 year fixed rates at 3.99%. So much so that I needed to write this blog post about where things are going and what you should do. In order to make a decision about what to do at this time we need to look at the facts and the reasons behind these rate moves. Then we need to look at where things are going and what our individual long term plans are with respect to our personal finances. I’ll start with the 10 year fixed rate option.

This week a select few lenders dropped some major bombs on mortgage rates. The first was a 10 year fixed rate as low as 3.84%. This move is unprecedented and has most people thinking of locking in. Let’s face it, can you really average a rate this low over a 10 year period? Trust me, I am not an advocate of going this long in a mortgage but it has me thinking about it too. There are many pluses in making a decision to move to a 10 year fixed at this rate. Your rate and payment will not change which makes up the largest component of your household expenses. The rate is still low enough that you could potentially accelerate your payments and pay your mortgage off quicker if not within the 10 year period. So why not?

Well, will you be in your property for 10 years? Does the mortgage allow you to port and what are the rules with respect to porting? For those of you who are new to this term, porting means that you can take your mortgage and its rate with you when you move to the next property. You will in fact get the same rate if there are no changes to your mortgage amount. It is very rare however that people port with the exact same mortgage amount. Under any other circumstances the rules change. So what happens if you port your mortgage and need more money? There are several possibilities. One, the lender could refuse the port and charge you a penalty. Two , the lender could refuse to port and have you accept another rate and term in lieu of a penalty. If this was the case would you have chosen a 10 year fixed in the first place? Probably not when 5 year fixed rates are really close to 3% right now. Three, the lender will give you a blended rate. This is where the lender blends the rate that you currently have with a rate that is available in the market when you need to port. It would be blended proportionately to the amount of money you need. Pre-recession 10 year fixed rates were close to 7%. In fact the majority of 10 year fixed rates in the market right now at just under 5%. If your rate was blended you would be facing a much higher rate than 3.84%. Would you have made the decision to go with a 10 year rate had you known? Probably not. So who does this work for? Well for one, it works really well for the banks who have you locked down for 10 years or face a penalty. It would also work really well for anyone who sees themselves being in their home for 10 years or longer. If this is you then this deal will never happen again and you should jump on it. One thing to remember is that fixed rates are based on bond yields. If bond yields rise then so do fixed mortgage rates. Currently the bond yield market is very unstable. Bond Yields have been moving sideways for weeks which leaves a lot of uncertainty as to where rates are going to be in the next month. This deal could be here today and gone tomorrow.  The same holds true with the 5 year fixed rate specials being offered right now.

On to our friends at the Bank of Montreal. BMO this week announced a historically low 5 year fixed rate of 2.99%. This has created a lot of press. To understand this move I need to share a little background on the situation. In the last few months our Big 5 banks have been urging the Bank of Canada to get rid of the 30 year amortization. Statistics throughout 2011 showed that Canadian Household debt is at an all-time high. There are many reasons for this and our banks feel that the 30 year amortization is one of them. A 30 year amortization allows people to afford more. It's no secret. The Bank of Canada over the last two years has dropped amortization periods from 40 years to 30 years to curb spending. Our Big Five Banks are of the opinion that if the Bank of Canada further reduces the 30 year amortization period to 25 years it would further cap household spending. This decision is being pushed by our country's top economists. My feeling is that this move may by quite premature.

The Bank of Canada only a year ago introduced a qualifying rate that banks had to adhere to when approving people for mortgages other than a 5 year fixed rate. This move significantly cut spending as people were forced into 5 year fixed rates. The logic behind this is that if people could stay in their homes for 5 years then they will have built up a significant amount of equity in that period of time. If they were not going to be locking in for 5 years then they would need to qualify at a higher rate in anticipation of mortgage rates moving back to normal levels in the near future. This makes a mortgage investment much more palatable for banks and insurers. The move was also a very responsible one in terms of people qualifying affordably for a mortgage. Did it hurt the market? No. It drove people away from riskier mortgage decisions. Lets face it, everyone and their brother has dreams of becoming the next Donald Trump. The problem is most don't bother doing any research. This move by the Bank of Canada saved them from themselves. Ultimately, I feel that it will take longer than one year for the implementation of the qualifying rate policy change to have an effect on the market. Especially now that variable rates are no longer an option.

Realistically though, our big 5 banks need to take a look at their internal practices first. When I qualify someone for a mortgage I am never looking to qualify them for their max. I am looking first at their personal budgets and then working backwards. Generally, I am leaving people with much more expendable cash to work with in their household budgets.  In fact, it's my absolute priority to achieve this. Have you every walked in to a bank and walked out with a printed budget breakdown based on your affordability? I don't think so. Shouldn't this be happening? I am not saying every Broker does this either but this should be the focus. Banks should be qualifying people in terms of living within their means rather than based on the Bank of Canada's guidelines. Its a mortgage broker and a bank's fiduciary duty to do so.

Let's look at an example of how the proposed amortization change could affect the market. If a First Time Home Buyer were trying to qualify for a mortgage of $250,000 the difference between a 30 year amortization and a 25 year amortization would be approximately $130 per month. This means that the same person would actually qualify for $30,000 less if they were forced to take a 25 year amortization. The significance of this is staggering. In Toronto, First Time Home Buyers represent the bulk of the market. This price reduction would put the largest purchasers of condos completely out of the market. This could have a catastrophic affect. Only two things could happen here. One, the first time home buyers do not purchase at all.  Or two, the sellers reduce their purchase prices. Either way this craters the market. If sellers reduce their prices then we have a self-fulfilling prophecy by our banks who only weeks ago predicted a decline in housing prices of 15%. Is this a conspiracy? I tell you this because this is what is behind BMO’s offer this week

The Bank of Montreal this week introduced the lowest 5 year fixed rate in the market. It came with some fine print though. It is only offered on a 25 year amortization and it does not include prepayment privieges other than a 10% payment increase. It is their way of testing the market in an attempt to support their case to eliminate the 30 year amortization. So let’s think about this for a second here. A 30 year amortization period would give someone a lower payment and the ability to save or payoff their mortgage quicker.  It would also come with prepayment privileges large enough to pay the mortgage off in as little as 5 years. Having a 30 year amortization does not limit people from paying off their mortgage quicker.  5 year fixed mortgage rates currently being offered in the market with a 30 year amortization period and full prepayment priviledges are very close to this rate anyways. If BMO needs to drop their rate to this level to make a 25 year amortization affordable then what happens when rates are not at this level?  If BMO is so interested in reducing consumer household debt, then why are they not offering full priviledges that would allow someone to pay off their mortgage quicker? Doesn't this defeat the purpose of the proposed change?  If bond yields spike then fixed rates are going to shoot up.  BMO’s offer is supposed to support the reduction of Consumer Household debt however it severely limits someone in having the ability to do so. Seriously? If a purchaser buys a house and does not live in it for 25 years what happens?  They arrange a new mortgage when they move and start all over again.  The 25 year amortization would not change anything.  A purchaser can be mortgaged for 100 years.  What it will do is reduce the number of people going out in to the market to purchase a home.  Although this offer is appealing to some those people do not make up the largest component of the market.  The people this will be appealing to will be those looking to refinance and who have 25 years or less remaining on their mortgage.  So BMO will be selling this rate to their own clients who already have mortgages with them.  They will also be stealing clients from the other major banks.  These people will also need to pay penalties to break their mortgages in order to obtain this new offer. What BMO and all of the other banks should be doing is educating their clients on how to better manage their money and household debt.  The fact of the matter is that consumers are not being educated and prequalified at the branch in a way that would promote better household spending.  If we destroy the First Time Home Buyer Market we will crater the Real Estate Market.

So what is the Bank of Canada saying about all of this? Oddly enough, not a whole lot. Over the past two years they made significant changes to mortgage rules and policies. The changes were all implemented at the begin of the second quarter of both 2010 and 2011. There was always advanced warning around the beginning of the year. Today the Bank of Canada announced that it was maintaining the target for the overnight rate at 1%. This means also that the bank prime lending rate will also remain once again at 3%. The Bank was also somewhat confident in the inflation outlook for Canada projecting stable inflation under 2% up to 2013. No mention of a Consumer Household Debt Issue. There were concerns about the European recession as well as slow growth in the US. Ultimately it was a pretty positive stance on our economy with no reason to raise the overnight rate or any reason to lower it either. It almost seems like the Bank of Canada is in some disagreement with our big 5. The fact that the big 5 will be using these major rate drops and the media attention to create hype is an indication that the Bank of Canada may not be supporting the idea of eliminating the 30 year amortization. So ultimately the power lies in the hands of the general public's response to this offering as well as the Bank of Canada's decision to do something about it.  Is a lower rate always better? What if your cash flow is affected? Ultimately the best decision the Bank of Canada could make would be to force people to qualify at a 25 year amortization for all rate types other than a 5 year fixed or longer. This would not eliminate the 30 year but would force people in to a better equity position. I believe the decision will be somewhat along these lines.  It makes sense to drive people towards better mortgage decisions.  Eliminating a good chunk of buyers in the market does not make any sense at all.  I am confident that the Bank of Canada will make the right decision in the end.  Only time will tell.