Unlike many investment advisers trained and experienced at providing retail investors with recommendations, as a manager of institutional funds over my career (mutual funds, pension plans and so forth) I’ve never felt comfortable providing advice to individuals; especially relatives. However, my wife is mulling over what to do about the mortgage on our home – the five year term is almost up for renewal. She’d also like to switch to from the bank to her credit union. I thought I’d share the haphazard analysis that my experienced but (admittedly a bit lazy) mind whips up.
The first issue is what is the bond market telling me about the future of rates. Generally, the yield curve – which is just a plot of what interest rates the government pays to borrow money from investors over various (short or long term) time periods. Circumstances today are substantially different that they were 5 years ago – in fact they’re much different than just one year ago as your can see from the graph.
A year ago, borrowing money for a five year term would have been at higher rates than are available for the same term (if you’re the government) today. Generally the yield curve is considered a predictor of the future – but expectations can change dramatically. The fact that longer term rates are lower than short term interest rates for virtually risk-free government bonds might suggest that the bond gurus out there are anticipating rates to fall even more in the future (whereas a year ago, the opposite was the case). Taken at face value, being able to lock-in a current interest rate for a renewed five-year might be inferior to simply agreeing to a floating rate mortgage.
What are current mortgage rates? Mortgage rates are generally higher than risk-free Canada Bond rates. Here’s a sampling:
Consider the rates for 25 year mortgages with fixed 5-year terms. Let’s focus on (a bit of apples to oranges, but I did say my analysis would be somewhat lazy) on the best rate of 2.48% and compare it to the below current Canada long term bond yield.
One thing that gets my attention is the narrow spread between the mortgage rate and Canada Bond rate of a mere 1%. WOW! Competition among the lenders (banks, credit unions etc.) for your business must be cutthroat nowadays.
If a 5-year term mortgage is coming due for renewal, then it was back in 2015 that the money was borrowed. At that time (according to Superbrokers.ca) the best 5-year rate was offered at 4.67%.
Since everyone’s objectives differ (minimize monthly payments, maximize savings over the life of the mortgage etc.) an analysis can get very complicated. I’ll stick to what I know – my wife is likely most concerned with the monthly payments. Also, as mentioned she’d like to switch to her credit union which presently offers only variable rate mortgages. The penalty for switching is $1000. What to do? Assume the amount of the loan is $100,000.
Pardon me for excessive rounding – but we’re making a decision here not vying for an award for precision. Renewing a $100,000 mortgage at roughly 2.50% will mean monthly payments (for the next five years) of $447.97/month (or total payments of $26,878.20 for the next five years). This compares to current (prior to renewal) monthly installments of $562.97/month (or over five years total payments of $33,778.20). Over five years she can expect to keep-in-pocket $6,900 in savings by simply renewing at a better current rate.
That’s the easy part. If – and it’s a really big ‘if’ – comparable savings would result even with a variable rate mortgage (and the bond market is telling us this seems pretty feasible) then the savings will more or less pay for the $1,000 cost of the switch. Presumably, the credit union will work hard to offer a lower rate than the banks over the life of the mortgage (some more savings here). It’s difficult to quantify both the monetary (lower fees for checking, ATM withdrawals and so forth) and the non-monetary (convenience, dividends from the credit union if applicable) benefits of moving the account. But clearly she can satisfy her urge to swap lenders without sacrificing a great deal, or simply lock-in an attractive five-year rate and enjoy significant savings.
For your information, there are plenty of mortgage calculators online (thankfully, because the battery on my handheld calculator died as I was working on this exercise) that you can use to do this sort of analysis yourself. If you’re lucky enough to have an investment or tax adviser I’m sure they can do a great job of helping you make sense of a tough decision given the uncertainty embodied in financial markets today.