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Mortgage interest rates from the Big Five Canadian banks reached all-time record lows this year, with Bank of Montreal lowering its five year fixed mortgage rate to 2.79 per cent earlier in March, and TD matching the rate a few days later. The credit union in Ontario also offered a limited promotion on an 18 month mortgage at an eyebrow-raising 1.49 per cent, driving flocks of consumers to their contact centres to inquire about the offer.
According to RateSupermarket.ca, that’s the lowest a federally regulated lender has ever gone. With mortgage originations being down and lenders fighting for market share in the face of an extremely cut-throat industry, Canada’s big banks are significantly slashing their prime rates and and altering the benchmark to maintain their competitive edge.
So what’s the catch?
As a real estate consumer, there are a few things to remember before locking into any mortgage agreement. There’s no denying that low rates are a great thing, especially for first time buyers. But before jumping on the bandwagon it’s important for borrowers to understand the penalties and clauses associated to the lower rate, especially since mortgage contracts are no longer standardized and can be hard for consumers to decipher without the guidance of an trustworthy mortgage broker or real estate broker.
Don’t lose sight of the forest for the trees:
The main risk with low rates is that it might prompt certain borrowers to get into the market when they really can’t afford it. With consumers becoming increasingly rate-sensitive, a sudden drop could mean losing sight of other priorities. Fixing the right term and making the right choice between a fixed and variable rate should come first in any mortgage decision, followed by the interest rate.
Borrowers need to look at their total debt service, personal lines of credit, investment loans, car loans, and household expense before determining whether they are, in fact, ready to become a homeowner. Don’t forget that a borrower’s debt service cost should never exceed 40% of their gross income, in order to leave a comfortable buffer for unexpected occurrences in the future.
Our advice would be: If you can’t afford a 4 or 5% rate now, and have no guarantee of increasing your income within the next five years, be careful about committing to the 2.9%. Consider that at the end of your term, when your mortgage is re-evaluated, rates are likely to rise again.
The federal government and the CMHC, worried that certain borrowers might be left vulnerable in the long term, have already taken steps to reduce some of the risks associated to the low interest rates. For example, any loan taken under $1 million and with less than a 20 per cent down must be accompanied with an insurance premium, which is added to the mortgage principle up front, and which protects the lender against default.
Another measure recently taken by the CMHC was to place a cap of 25 years on the amortization period of these insured loans. The shorter amortization period has increased the costs of the monthly payments but on the long run works to the advantage of the borrower. It also prevents borrowers with bad risk profiles from entering the market too early.
These measures are designed to give borrowers a cushion against higher interest rates in the future, by ensuring that all borrowers be able to meet the standards of their five year fixed mortgage rate even if they choose a shorter term, lower interest rate or variable rate with a shorter term.
Mind the Clauses
Before being swept away by the lure of a lower rate, consumers should inform themselves thoroughly on conditions attached to their exchange. By chasing the 5 extra basis points, buyers may have to pay far greater penalties further down the road.
For example, in some cases, the lower rates are exchanged for steeper penalties for paying off a mortgage early. The consequences for breaking the mortgage early (before the five year term) can also be extremely severe in these competitive loans. It’s important to read the fine print carefully when considering any promotion offered during a rate war between lenders.
Can you take a hike?
The choice between a fixed or a variable mortgage rate is probably the most important one you’ll have to make. Though many people opt for the five year fixed rate mortgage due to its predictable and stable nature, variable mortgage rates are oftentimes the smarter move to make. In the long term, they tend to pay off. Over the past 30 years, results from the bank of Canada have shown that though rates peaked in the early 80’s, they’ve been on a declining slope since then, making it a bad move for Canadians to opt for the fixed rate option. (see image below)
That being said, many Canadian households struggle to keep a hold on ever increasing childcare costs, education costs, and flatlining incomes. For people in a struggling situation, fixed rates can act as a kind of buffer.For people who won’t be able to deal with unexpected additional costs. fixed rates certainly have their appeal.
All in all, evaluating the optimal duration and type of mortgage greatly depends on your financial stability, long term goals, and receptiveness to risk. Picking a mortgage lender should never be based solely on points, but rather by evaluating the overall adaptability of the offer to your personal portfolio.
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