5-year mortgage – follow the 10 year US bond

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In 1979 I received a call from my brother about what he should do. He just bought a new house in a new neighbourhood and mortgage rates were in the low teens. All his neighbours were going 1-year. The 5-year rate was much higher at 13.5%. I knew interest rates were going up.

I explained that when the fed, or any central bank for that matter, picks a direction for rates, it will go longer and farther than people expect. They were raising rates to fight inflation and all you could find in the press was that rates were at a peak. Boy was the press wrong. I asked if he could afford the 5 year rate he should lock in for 5 years. He did this.

In 1980 one year after they bought their houses, his neighbours renewed for one year at 13.5%, equal to last year’s 5-year rate.

In 1981 two years after they bought their houses, the 1-year rate had almost doubled to 21.25% and the 5 year had risen to 21.75%. Many of his neighbours could no longer afford their houses and started selling their houses at a loss. He estimated that about ½ of his neighbours had to sell.

At the top - 1981

At the top in 1981 we started a downward trajectory in mortgage rates that has probably just bottomed.

The trend went farther and much longer that anyone could imagine in 1981. Remember, there were a few up spikes on the way down, but the overall long term trend was down. If you told people that this would be the final result, you would have been laughed at up until 2007.

In Canada the variable rate mortgages are generally linked to the Bank of Canada Key Lending Rate. Fixed rate mortgages key off of the U.S. bond market.

The trend in mortgage rates was down for 34 years. We have been at the bottom in Government rates for the last 7 years. I have been telling my clients to stop listening to the press and talking heads since 2009, as the vast majority have been confusing the public with their statements that rates will go up soon. For 7 years they have been wrong.

The Upbeat Fed

Remember the Fed must keep everyone hoping for a better economy and thus always give the feeling of a rosy future, which could increase rates. If the fed was negative in any way, it would be disastrous to the economy.
The U.S. Fed’s problem is that once they change directions the trend they will continue that trend into the future. They want their increase to show faith in their economy, but don’t want to destroy any tenuous growth with higher rates.

We are at a watershed time

We are at a watershed time, just like my brother was in 1979, though he bought in the middle of a trend. If you believe U.S. interest rates will rise - no matter how slowly - you should lock-in the 5-year rate on your next maturity.

I contacted a good mortgage broker that I work with to find out the best mortgage rates today and found the following:

Variable (3-year)                 2.20%
1-year                                   2.29%
5-year                                   2.74%

This is an incredibly flat rate curve with a .45% difference between a 1-year and a 5-year. This difference has traditionally been 1.25%. You have to aware of the conditions of each of the mortgages you are comparing.

Your decision has a lot to do with your expectation of US bond interest rates. Remember that bonds move in anticipation of economic times. The market does not wait until rate announcements to change the interest rates on bonds. Paying less on mortgage interest allows you to intelligently increase your wealth over the long term.

The trend will again be bigger and longer than expected

When rates do start to go up, they will go up higher and over a longer term than anyone will predict at the beginning; they always have. In the past we had to see the interest rate moves to know if we were at the peak or bottom of the trough. With interest rates this low, some of the questions are already answered.

YOUR INDEPENDENCE MATTERS and if you want to see what a truly independent investment/insurance advisor can do for you, call me at 905-846-9060, ext.3838, email me at Terry.McIntyre@manulifesecurities.ca or visit my website at www.terrymcintyre.ca