How Market Changes can Affect Mortgage Decisions

[smilingmeng]

The single biggest dilemma for Canadian mortgage borrowers since 1992 has been whether or not to lock in to a long term mortgage or stay ’short’. History has shown that, overall, it might have been better to stick with a short term or variable rate mortgage. That, however, is 20/20 hindsight, and many who locked in their mortgage at 6.75% in March of 1994 and then watched as rates zoomed through the roof when constitutional discord ravaged the Canadian dollar, would argue that they got the better of the deal. It remains to be seen what the next decade will hold. Let’s consider a few of the dynamics directly affecting rates, and then see how personal mortgage decisions might be affected.It is clear to see that accuracy in interest rate prediction can only be judged after all the world’s political and economic events have worked their way through the bond market over a period of time. One of the brightest analysts in Canada predicted a cataclysmic National Debt for Canada by the turn of the century, even suggesting that the International Monetary Fund (IMF) would have to place controls over the Canadian currency and foreign borrowings in order to stabilize the situation. Interest rates were confidently predicted by some to be heading back to double digits by the year 2000.And yet, following severe damage control by the Bank of Canada in the late 1980’s and early 90’s, through draconian monetary policies, combined with fiscal restraint and heavy cutbacks by the Federal Government, Canada’s financial house appears to be in order, paving the way for stable growth with a well controlled interest rate market.In Canada, the threat of Quebec separation continues to be the ’wild card’ which could tip the balance in terms of whether the Canadian dollar once again undergoes a prolonged attack. This would force the Bank of Canada to once again defend the dollar by driving up short-term rates and causing Canadian Bonds to be heavily discounted in the market. This would in turn drive up long term rates as explained in the previous section.This leads us to the conclusion that there are three basic strategies that Canadians could follow given the current state of the market. Each is represented by a "risk tolerance" on the part of borrowers:・ Stay ’short’ with a 6 month convertible or variable rate mortgage, watching for indications that a long lasting upheaval warrants either a long-term lock-in or a ’hedging’ strategy. This approach is for the ’risk-taker’, or the borrower who can easily absorb significant rate hikes and is prepared to live with a reasonable average over the long haul. ・ Hedge your bets by either taking a protected variable rate mortgage with a ceiling at 3 and 5 year current posted rates; or a split-term mortgage with terms varying from 6 months to 5 years, in amounts which suit your risk tolerance level. This strategy is the best for those that are cautious, and possibly vulnerable to significant rate increases in the near term...or simply partners with different risk tolerances!・ Lock in now, after negotiating your best long term rate - as long as 10 years from some lenders. This dispels all concerns about the direction of the market, and gives the risk-averse borrower an opportunity to reduce their mortgage balance significantly before they are once again exposed to interest rate risk.
by Oleg Shiller