Mortgage risk and reward

Mortgage risk and reward – Financial experts say variable-rate mortgages save money, but still half of all homeowners choose the lock-in option. Good article, worth a read.

*** Nov 1, 2011 Update:

The above link doesn’t work any more. Here is a different link from York university directly. And here is a link to Dr. Moshe Arye Milevsky‘s March 2001 research paper “Mortgage Financing: Floating Your Way to Prosperity” on his research paper site.

Calgary Herald cites Schulich professor’s research: Mortgage holders better off choosing variable rates

Posted on 16 May 2010. Tags: 

Mortgage risk and reward

Financial experts say variable-rate mortgages save money, but still half of all homeowners choose the lock-in option

By Deborah Yedlin, Calgary Herald
May 16, 2010

As the Bank of Canada appears closer to moving away from the historically low rates that have been in place since financial markets melted down in 2008, the inevitable is upon Canadian consumers: interest rates are about to rise.

The question is when and by how much.

And if you happen to be in the market for a mortgage, the question of what to do — lock-in or float — looms large.

Of course, the big banks have already starting ratcheting up rates, with the Royal Bank of Canada and the TD Bank boosting rates well in advance of June 1 — the first opportunity in which the Bank of Canada could begin its tightening process.

For homebuyers, the difference in half a percentage point could very well mean being priced out of the market, if not a particular home.

“Traditionally . . . going back 30 or 40 years . . . the longer you’re in a variable rate mortgage, the further ahead you will be,” says Don Peard, vice-president, mortgage specialist for Alberta, with the Royal Bank of Canada.

But not everyone can afford to deal with the uncertainty of not knowing exactly what their monthly mortgage payment will be, even if it is at a lower rate.

“If I am a first-or second-time homebuyer and need to rely on both mine and my partner’s salaries, there’s comfort in knowing what my payment is every month,” says Peard.

But a study by York University Prof. Moshe Milevsky shows borrowers are better off if they choose the variable rate option — and by a huge margin.

Milevsky looked not just at what the savings are as a result of being charged a lower rate, he also assumed the difference between the fixed and variable payments was invested in 91 day treasury bills.

Using this methodology Milevsky concluded a borrower was better off 90 per cent of the time when they chose the variable option over locking-in at a fixed rate.

He debunked the notion that mortgage holders can come out ahead if they play the short-term end of the interest rate curve and lock-in at a certain interest rate.

“Even Canadians who can accurately predict the next move of the Bank of Canada, and lock in a mortgage just as the short rate is about to increase, are worse off on average compared with those who float over the entire interest rate cycle,” wrote Milevsky.

Continue reading this article in the Calgary Herald…


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