Ten year fixed rates are turning a lot of heads these days. I wasn’t among the admiring onlookers before, but at 3.69%, I’ve been seduced by its alluring charms. If you haven’t heard, fixed mortgage rates are on the move and it’s not looking pretty. Yes, rates are moody creatures that float up and down all the time, but this occasion is different. Let’s delve into a little context.
Last week Wednesday, Ben Bernanke—Chairman of the Federal Reserve announced a phasing out of the $85 billion dollar monthly bond purchasing program by the middle of next year–2014.
His announcement effectively brings to a winding close the era of cheap money that consumers have grown accustomed to—thinking it’s the norm. The program was designed after the 2008 financial crisis with the goal of boosting the economy by reducing the barriers to long term borrowing.
If you recall, immediately following the Lehman Brothers failure—a catalyst to the 2008 meltdown—lending on the continent came to a virtual halt. Businesses could not finance investment in new plants, equipment or employees. Consumers could not access credit for such important things as buying shiny new cars or renovating that kitchen so out of vogue with the times…
The solution hatched up by the Federal Reserve was to attack interest rates by any means necessary. How do you do that? One way is to create a steady demand for treasury bonds by systematically buying them up to the tune of say $85 billion dollars per month.
The steady demand kept bond prices high, which in turn, kept yields low. Yields are what long term interest rates are based on so imagine a scenario where yields that were artificially kept low, now losing their inhibitions, begin to rise. That movie is coming to a screen near you.
On Wednesday, the yield on Government of Canada five-year bond (the benchmark for five-year mortgage rates) sat at around 1.66. By today, Monday afternoon, those yields had risen to 1.87, a 21 basis point jump in less than 3 business days.
“We have got away with murder recently with the low interest rates,” says Ron Meisels, president of Phases & Cycles Inc. an investment research firm in Montreal.
Taking a quick glance at rate movements earlier, I noticed all the major banks and most of the rate-aggressive lenders operating exclusively through the broker channel, have all upped their fixed rates for the 2nd time in less than four 72 hours.
The days of below 3% rates by major lenders are coming to a close—perhaps never to return. Bear in mind that only three weeks ago some brokers were able to secure discounted rates to the tune of 2.79% for qualified clients. The average now lurks between 3.09-3.45% for a 5 year fixed. How the winds have changed.
What can you do to combat this return to reality if you’re just entering the market? There is no simple strategy, but I would encourage you to run, not walk, to your broker or lender placing your bets on the long haul, 10-years long to be exact. As of this writing, the best 10 year fixed rate is approximately 3.69%–a figure I doubt will remain intact by the end of week. Here are five reasons to consider a 10-year fixed mortgage:
- You are not held captive for the full ten years. After 5 years, by law in Canada, you’re allowed to break a 10-year fixed with only a measly 3-month penalty.
- If you invest in properties and have tenants, the longer timeline allows you to easily predict and calculate your cash flow knowing that the interest rate risk is removed for 10 years-if you so choose.
- You avoid the potential spook of a higher rate come time for renewal. For retirees or folks on fixed incomes especially, a ten-year fixed offers protection and income to expense ratio stability over the long haul.
- 4% has been the 20 year average for a 5 year fixed mortgage; that’s only 0.31% more than the 3.69% secured for 10 years. When has long term financing been this cheap?
- What if worst case scenario we see a significant dip in the property market over the next 5 years? Lenders could simply refuse to renew your mortgage and demand payment at renewal if market values dive in concurrent, multiple quarters. With a 10 year-fixed, you have enough time to whether any potential storm and plan out your next move.
Keep in mind a few tidbits. Variable rates are influenced by the prime rate, a figure that the Bank of Canada has held steady for almost 3 years strong. Here’s one leading thinker’s view:
“In these extraordinary economic times, I believe that history is less relevant for the purpose of forecasting or projecting future interest rates. Indeed, the volatility of short-term rates in the last few years has been close to zero. But it would be ridiculous to extrapolate that volatility is dead.” Moshe Milevsky
Fixed rates on the other hand, are influenced by the Government of Canada five-year bond yields—which is tied further to the U.S. Ten-year Treasury bond yields, the bedrock of the global financial system.
It’s possible that this hype we are seeing in the markets might cool, returning rates to their very recent artificial levels. I would go out on a limb to suggest that any such retreat would be a temporary blip—one that’s likely to continue their pre-ordained upward march. Until then, the 10-year fixed still has sex appeal.