10 Year Fixed Rates: a mortgage strategy to protect against future inflation and as a result, protecting your family’s budget. As a mortgage planner and debt manager, I find it imperative to educate everyone on the security and benefits of a long term fixed rate as one of their financing options when purchasing a home, refinancing or transferring a mortgage.
Change in Mortgage Rates: Fixed vs. Variable
Over the last 10 years, averaged rates have sat within a specific spectrum:
- 5 year fixed rates – average wholesale discounted 5 year fixed rates have been between 5.50% to 5.75%.
- 10 year fixed rates – average 10 year fixed rates have averaged 1.50% higher than the 5 year fixed rates at around 7-7.50%.
After the global credit crisis in 2008, including recession concerns in Canada, the Bank of Canada sharply started reducing interest rates to the historical lows we have had available over last couple of years. During this time frame, many Canadian consumers took advantage of the variable rate programs and deep discounts below the prime rate, saving thousands of dollars in interest over the fixed rate programs.
Recently, in the last 2 years, we have seen the deep variable discounts trimmed away by lenders due to weakening spreads of profits and liquidity concerns placed on banks, complying with the new regulatory changes I have referenced in my prior articles. As a whole, variable rate mortgages do not offer a significant reduction in rate as compared to fixed rates anymore and have been priced out of the market under most circumstances. There are certain mortgage strategies where the variable rate programs do make sense, based on individual needs and plans for the mortgage and the property.
Today’s Interest Rate Environment
We are still enjoying historically low interest rates. This has also provided a unique interest rate opportunity we have not seen ever in the past.
5 year discounted wholesale rates are ranging from 2.99% to 3.19% and the 10 yr fixed rates are in the 3.89% to 3.99% range. This is the first time in interest rate history that the difference between the 5 year and 10 year rates are less than 1%.
Interest Rates into the Future
There have been numerous articles by national economists and hints by the Bank Of Canada that it’s not a question of if interest rates will rise but when. As signs of a strengthening economy in Canada – and stabilization in the world markets – continue, we will see a gradual increase in interest rates regardless of what’s happening in the US markets. In the present time, based on key economic indicators, rates may continue at the same level or possibly even reduce a bit more. My concern is for the future rate increases.
Benefits of considering a 10 year fixed versus a shorter fixed term
1. Prevention of Payment Shock
Take this example: If you have a $400,000 mortgage at 3.09% interest, your monthly principal and interest payment based on a 25 year amortization would be $1,911.50. If your mortgage renews in 5 years and the current rate at that time is 5.50% (the average 5 year fixed rate from the last 10 years), your payment would increase to $2,441.57. That is an increase of $530.00 in mortgage payment overnight!
There is a serious potential that the new mortgage payment would have a major negative impact on a family’s overall financial situation and might take cash flow away from investments, retirement funds or from the ability to pay extra on their mortgage to pay off their home sooner, something many Canadian’s are doing (RateHub Infographic).
Securing a 10 yr fixed at 3.89% at a payment of $2,080, qualified on today’s current earnings and debts, would protect the borrower from potential payment shock in the future.
If you were to sell your home within the 10 year period, you have the benefit of porting your mortgage and lower rate to your new home. This would dramatically reduce your cost of borrowing, especially if market rates have increased at that time.
3. Prepayment Privileges
The 10 year fixed mortgage allows the same type of prepayment privileges, monthly and annually, as the 5 year fixed mortgage. In conjunction with this, if you choose to break your mortgage early and not port it, you are subject to the IRD (interest rate differential) penalty during the first 5 years but the remaining 5 years converts to only a 3 month interest charge similar to a variable rate mortgage.
The 10 year fixed has many benefits and strategies to be considered. While some consumers would rather take a shorter term fixed and pay less interest now and hedge the market, I feel that first time home buyers and more conservative homeowners, there are definite benefits for consideration.
If you are an investment property owner and can have a positive cash flow based on a 10 year rate, there is definite security to preserve that cash flow if you do not have to go back into the market in 5 years and potentially pay a higher rate and mortgage payment. A jump in 1.50% to 2% in interest would not be offset by the gradual rent increases you are allowed to charge your tenants annually.
There are many strategies to optimize your mortgage to get out of debt sooner and increase your investment & retirement returns using your mortgage as a vehicle for wealth accumulation.