Standardizing Mortgage Penalty Calculations

Rob McLister, CMT
Two years ago, the government pledged to “standardize the calculation and disclosure of mortgage prepayment penalties.”
It addressed the disclosure problem last week (see:New Mortgage Penalty Disclosure), but it has done nothing to standardize the actual calculation itself.
This lack of action irritates some consumer advocates. They feel that lenders’ convoluted and algebraic penalty formulas allow them to overcharge people. (How to define “overcharge” is another question.)
As to why the government chose not to standardize penalty calculations, a Department of Finance (DOF) official told us:
“Mortgages can have a variety of mortgage prepayment calculations. Standardizing the calculation of the mortgage charges could have resulted in changes to lenders’ product offerings and created a disincentive for some lenders to offer discounted rates to the most creditworthy borrowers.”
The DOF concluded that, “This would not have been in consumers’ best interests.”
Instead, the DOF says “The Mortgage Prepayment InformationCode of Conduct focuses on disclosing key mortgage prepayment information that equips consumers to understand and benefit from a choice in mortgages.”
Unsurprisingly, that leaves two camps in the penalty standardization debate: Those for it and those against it.
Pro-Standardization
Some people are outraged at the thought of banks profiting from mortgage penalties. We’ve all heard stories of eye-popping prepayment charges in the tens of thousands of dollars.
There are many people who would therefore like to cap mortgage prepayment fees.
Others would prefer to see a standard penalty formula that is applied consistently regardless of the lender. In this case, breaking a mortgage with a given mortgage amount and interest rate would trigger the same penalty regardless of the lender.
Another idea is to allow lenders flexibility in how much they charge, but to legislate the penalty range and calculation method. In that case, all lenders would calculate the base penalty the same way. They could then charge a simple multiple (e.g., 1X, 2X, etc.) of that penalty at their discretion, subject to:
The base penalty formula being straightforward
The multiple being disclosed up front
The total penalty not exceeding the maximum allowed by law.
The Case Against Standardization
The original intention of mortgage penalties (more accurately called “interest compensation charges”) was to make a lender whole if the borrower backed out of a mortgage contract that he/she voluntarily agreed to.
Without such compensation, the lender would have less ability to cover costs and repay depositors and/or investors who provided the money to lend to the borrower.
Put another way, a mortgage penalty is similar to the compensation we might expect if we bought a 5% GIC and the bank cancelled it when rates dropped to 2%. We’d demand the rate we had been promised, especially if there was no place left to invest at a similar yield.
Most of the time, mortgage compensation charges are not the cash cow people think they are. (There are exceptions of course.) Last quarter, for example, CIBC reported that its prepayment fees collected from customers were actually lower than the true breakage costs to the bank. That appeared to be an industry-wide trend, according to CIBC's earnings release.
In many cases, when a customer breaks his/her contract, penalties only cover the interest a lender loses; lenders incur many more expenses when a mortgage is broken. Lost interest is just one.
Further, many would argue that standardized penalties are self-defeating. Forcing lenders to apply a single penalty formula for early termination would restrict lenders from charging what they deem necessary to become whole.
That one-size-fits-all penalty would likely drive lenders to add a rate premium to every single mortgage to compensate for the lost interest revenue. No one would be further ahead, monetarily anyways.
In a free market where mortgage lenders can generally choose what interest rate and fees to charge, it's difficult to justify legislating a specific calculation method for interest compensation. Lenders have different costs, different mortgage features, different mortgage flexibility, and different profit margins. Being forced to levy the same penalty for a given rate and loan amount makes little business sense.
Mind you, some lenders might be able to tolerate a compromise in which a set method is legislated for calculating a range of penalties. In that case, all lenders would determine the "base penalty" the same way, based on the borrower's contract rate, term remaining and standardcomparison rates. A lender could then charge some multiple of that base penalty, up to a regulated maximum. This system would help borrowers compare lenders’ penalties more easily, while still providing flexibility for lenders to recoup costs as needed.

Different way to use your RRSPs

For those tired of paying mortgage interest to a bank, there is a technique that allows you to use your retirement savings to help buy your home or even finance a cottage or investment property.

The technique is known as a self-directed mortgage and is not widely used. In fact, Rowena Chan, a vice president with discount broker TD Waterhouse, says it’s one of the “least common” investments she deals with. But for those who have a mortgage, are looking for a fixed income investment, and have more than $50,000 sitting in their RRSP, it’s an option they might consider.

This is how it works:

There must be cash in your RRSP that you can borrow in what is called a non-arms length mortgage and the transaction must be made through a bank, bank broker or licensed lender. The lump sum is borrowed and applied to the mortgage and like a regular mortgage, a repayment schedule is set up. Those payments go directly into your RRSP and you keep all the interest. The interest rate must be the same as the posted rate at the bank, but like any other mortgage you can shop around for different rates at different lenders.

Gerry Hogenhout firm Hogenhout & Associates Inc. specializes in these investment vehicles. He says anyone thinking of using this investment needs to clearly understand what’s involved, including the fees.

TD Waterhouse charges $250 to set up the account and has an annual $225 account fee. Regardless of the equity in your home, the entire amount has to be insured by CMHC, which is 0.5 per cent of the entire loan. This is a good thing because you are protecting your retirement savings. Also budget about $1,000 for legal and other professional fees.

So it is worth it?

Suppose you have $50,000 cash sitting in your RRSP and a mortgage on your home. You borrow the $50,000 and pay down your mortgage, repaying your RRSP every two weeks over a five-year term. The interest paid is not a contribution, but is treated the same as a dividend payment from a stock you hold in your RRSP.

The current five-year fixed rate is 5.19 per cent. Your bi-weekly payments are $136 and after five years will have paid more than $12,000 in interest and $6000 towards principal. Your fees, insurance costs and legal charges will total approximately $2,625. That leaves more than $9,500 that you would have paid to the bank that is now in your RRSP.

If you take that same $50,000 inside your RRSP and invest it in a fixed rate GIC at the current 2.75 per cent with Ally Bank your investment will grow to $57,369. Total gain approximately $7,300.

And you will still be paying interest on the $50,000 you owe to the bank.

You can also use your self-directed mortgage to lend money to a third party in what is referred to as an arms length mortgage. There’s more risk involved and for this reason you can charge a higher interest rate. The money is lent to a third party who repays it monthly like a normal mortgage. In this case you are often lending to borrowers looking to expand their business into a new property or buy more real estate and the banks won’t lend them the money.

As with all investing, self directed mortgages are not for everyone. They aren’t for those looking to make quick gains. They also require a long-term commitment, because unlike a stock you can’t sell your self-directed mortgage. They also require the account holder to have a large amount of cash in their portfolio that they are willing to invest for the long term. And always there are risks because home values could fall and your mortgage could be more than the property it is backing.

Always consult a financial planner before committing to any investment method.

Rubina Ahmed Haq is a Toronto freelance writer. Reach her at rubinaahmedhaq@gmail.com

Sharie Marie Mortgage Team wins Big Award

Heather Thomson, Alberni Valley Times

Published: Monday, January 30, 2012

Only a year after starting her business, Sharie Marie Francoeur has been named real estate company of the year.

Francoeur was excited and surprised when she won the Vancouver Island Business Award, handed out by the Business Examiner on Thursday night in Victoria.

"It gives our team some recognition and shows people they can have faith in us," she said.

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"And it makes me feel more confident in growing my team."

In 2011, Francoeur set up Sharie Marie Mortgage Team in Port Alberni. She grew up here, and had been living in Victoria since she graduated from Alberni District Secondary School five years ago. But her love of the city and its community feel brought her back.

Francoeur thinks one of the reasons she won was the speed at which the company grew. She also established the Mortgage Mentoring Program in Ladysmith, which put her up for the entrepreneur of the year award on Thursday night. Through that program, her company has grown rapidly. She now has 10 licenced mortgage brokers and 13 in training. Two are in Port Alberni, and the rest are around Vancouver Island.

"I wanted to help other mort-gage brokers learn, not only what's in the books, but what they will need in the job," she said.

Francoeur was not the only Alberni Valley business to be nominated in these awards. Seven other businesses got the nod, including Van Isle Ford, Kismet Quilts (small business), West Coast SLAM (community leader), Catalyst Paper (forestry/wood products company), NSS Investments (real estate), Trends Design Team and Trends 2 (small business) and Acoustic Wood Ltd. (small business).

"Port Alberni tends to have a really negative image," Francoeur explained. "It is important that business owners in small towns, especially Port, get out there and show what we can really do and start to change that image."

Even being nominated offers advantages. Rosanne Gray, owner of Trends Design Team, said they are grateful for the community support and honoured to be nominated again this year.

"The competition was very tough, and we are very proud to be included in the same category as the other finalists," Gray said. "Trends Design Team will continue to provide professional services to all our customers and look forward to continued success and growth."

HThomson@avtimes.net

CMHC Portfolio Insurance

CMHC Insurance Limits: A Wake-up Call for Lenders

Many have now seen this National Post article.

The gist of it: CMHC is approaching its $600 billion government-imposed limit on issuing mortgage default insurance. That’s happening largely because of lenders’ enormous appetite for something called portfolio insurance (a.k.a., “bulk insurance”).

No one fully grasps the repercussions yet, but our sense is that the news is not great (at least in the short-to-medium term) for mortgage consumers, smaller lenders and brokers.

On the other hand, it may be healthy long-term for the housing market. Here’s why…

What is Portfolio Insurance?

Mortgage default insurance is typically only “required” when someone with less than 20% equity gets a mortgage.

Despite that, almost three-quarters of CMHC’s outstanding mortgage insurance is low-ratio (i.e., 20% equity or more). That’s largely because banks have been buying portfolio insurance in gobs to insure against defaults on low-risk conventional mortgages.

Banks do that because, even though the risk is low, there is still risk. Investors who buy these mortgages like to know that the government is behind them, if borrowers default and the lender can’t pay up. Because of regulatory capital rules, bulk insurance also enables banks to lend more with the precious capital they have.

CMHC summarizes portfolio insurance as follows:

“Portfolio insurance helps lenders manage their capital more efficiently and small lenders to compete on an equal footing with large lenders. It allows more lenders to compete in the mortgage loan insurance market by lowering entry barriers, thus expanding consumer choice.”

Note: Nothing is changing with high-ratio insured mortgages. So if you’re getting a mortgage with less than 20%, this news probably won’t impact you (for a while at least).

CMHC’s Insurance Limit

Despite the above benefits, we’re hearing that CMHC has announced it is slashing the amount of bulk insurance lenders can access. That’s because CMHC is limited by law to writing no more than $600 billion worth of policies.

Normally, every 3-5 years as the mortgage market grows, CMHC has asked for, and received, approval from parliament to raise this limit. It was last raised by $150 billion in 2008.

Now media frenzy has politicians scurrying to offload mortgage risk from the government back to the private sector. (The government guarantees CMHC’s liabilities, so public concern is certainly understandable.)

As a result, many question whether CMHC will get its $600 billion limit raised anytime soon.

Here’s some reaction on that:

• TD Bank economist Sonya Gulati tells CBC that not increasing the limit “may serve to tighten the housing market."
• RBC economist Robert Hogue told Global News that increasing the limit “…would be, policywise, a very delicate balance to strike."
• The Post quoted an unnamed industry source as saying: “...What will the government do, not increase (CMHC’s) limit? This could kill the entire housing market.”

Who Uses Portfolio Insurance?

Portfolio insurance is widely relied on by many smaller lenders who must resell their mortgages (as opposed to fund them from deposits).

More commonly, portfolio insurance is used by the Big 6 Banks. That’s because insured mortgages have virtually a “zero-risk” weighting in regulators’ eyes, allowing banks to lend more, earn higher returns, and keep mortgage rates lower than otherwise possible.

(One fast-growing use of bulk insurance is for guaranteeing covered bonds. Covered bonds are a relatively new source of mortgage funding in Canada. More on that here.)

In any event, spokesperson, Charles Sauriol, says CMHC “has recently received an unexpected level of requests for large amounts of CMHC portfolio insurance.” That insurance is using up CMHC’s capacity.

(Incidentally, the biggest bulk insurance customer recently has been Scotiabank, which reportedly had an abnormally large and predominantly insured $17+ billion mortgage-backed securities issuance in December.)

The Risk of Portfolio Insurance

Portfolio insurance can sell like hotcakes indefinitely, and there will never be a problem…unless the unthinkable happens: mass defaults.

The question then becomes: Are insurers taking in enough in premiums to offset potential claims—thus avoiding a federal bailout?

In exploring that question, it’s important to remember that there’s a relatively strong relationship between default risk and loan-to-value (LTV). In other words, the more equity a mortgagor has, the less likely they’ll stop making their payments.

That said, if housing were to crash, insurer claims on portfolio insurance would soar. The premiums they’ve collected from lenders are their first line of defense in that case (unlike high-ratio insurance, lenders usually pay the premiums on portfolio insurance themselves, not the borrower).

According to a very good source, however, there is a problem with these premiums. Major banks have negotiated the premiums down to levels that may not be enough to cover extreme conventional default rates.

(We haven’t found any current data on conventional mortgage default rates, but they’re ostensibly less than the 0.38% for overall arrears—a number which includes higher-risk, high-ratio mortgages.)

CMHC’s Wherewithal

CMHC has continually been accused, in the media, of creating undue risk for Canadian taxpayers. A few weeks ago, we spoke with Pierre Serré, Vice- President, CMHC Insurance Product and Business Development, to try and get a sense for that risk.

He stated: “…We focus on prudent underwriting practices and the adequacy of our capital levels. CMHC is well positioned through its available capital to handle even extremely adverse economic conditions.”

He noted that CMHC has a total of $17.4 billion that could be used to back-up its insurance business and pay claims.

CMHC's actual losses on claims have been much lower. They were $454 million for the first nine months of 2011, for example. That coincides with a 0.42% default rate.

CMHC has 38 times that $454 million in capital and reserves to cover adverse housing shocks. It can handle some pretty devastating housing scenarios, especially given that the average mortgage in its portfolio has equity of 45%.

Net of all claims and expenses, CMHC’s insurance business earned a total of $1.042 billion in Q1-Q3 2011. Moreover, contrary to many critics, CMHC’s core mortgage insurance business has never needed to be bailed out.

“…There has been no reimbursement of funds by the Government of Canada with respect to CMHC’s commercial mortgage insurance operations,” said Serré. “The losses CMHC experienced in the early 1980s (shortfalls totalling $555.6 million) were a result of costs under two specific government programs, the Assisted Homeownership Program (AHOP) and the Assisted Rental Program (ARP).”

“CMHC's mandate for its mortgage insurance business was changed in 1997 to allow it to operate on a commercial basis without having to rely on the Government of Canada for support,” Serré said, “even in less favourable economic times.”

(If you’re interested, see page 99 of this report for CMHC’s estimates of losses given a 100 bps rate increase, adverse unemployment, or slowing home prices.)

In a bad-case scenario (e.g., severe prolonged unemployment or a dramatic spike in rates), you can darn well bet our housing market would get butchered. The harshest critics we’ve spoken with say you could take today’s average loss numbers and multiply them by 15-20.

Well, if you do that, it would be far beyond any insurance losses Canada has ever experienced. Yet, in that scenario, CMHC would still have billions in capital left over before asking for government handouts.

Potential Outcomes

Looking forward, CMHC’s cutback on bulk insurance has numerous potential repercussions. No one has the answers yet because we're still waiting to see how things shake out.

That said, here's our best guess. Barring a CMHC announcement that it's raising its portfolio insurance limits, then:

1. Smaller lenders may be forced to pay more for conventional mortgage funding (for some period of time).
   • This could kill off rate competition from many non-bank lenders in the conventional mortgage market (Banks are probably licking their chops at this prospect.)
2. Bank capital costs could potentially increase.
   • That would impact earnings and/or lift mortgage rates somewhat (to what extent we don’t know.)
3. It would discourage new non-bank lenders from entering the market,
   • Resulting in less choice for mortgage shoppers.
4. It would force lenders to find alternative, uninsured funding sources for conventional mortgages.
   • That’s largely a positive long-term—to the extent it would cut government exposure in the unlikely event of mass conventional mortgage defaults.
5. It may kick-start the uninsured covered bond market.
   • Uninsured covered bonds transfer risk from the government to major financial institutions.
   • “…We believe there is a high probability that Canadian banks will not be permitted to use CMHC-insured mortgages” as collateral for future covered bond issuance, BMO Capital Markets analyst, George Lazarevski, told the Financial Post.
   • So far in Canada, only RBC has issued uninsured covered bonds. Those bonds are rated AAA and mostly consist of 5-year fixed mortgages with a typical LTV near 72%.
   • Unfortunately, most smaller lenders have almost no access to covered bond funding.
   • These developments may very well encourage the government to lift its current bank limit on covered bond issuance (which is 4% of bank assets). If the government doesn’t, and it continues to restrain bulk insurance, lenders tell us it could seriously harm conventional mortgage liquidity.
6. Given their reduced access to portfolio insurance (and thus the reduced potential for low-ratio mortgage business), smaller lenders may now get even more choosy on which conventional borrowers they lend to.
   • This could limit conventional mortgage options somewhat, unless you were a top-qualified borrower
7. Brokers may be increasingly forced to rely on banks for conventional financing.
   • It’s not unthinkable that banks respond with higher pricing on conventional mortgages, given the greater funding costs and demand from brokers.
   • Some industry observers doubt that banks would price quite as high in their retail channels (since they favour those channels).
8. Private insurers may realize benefits from all this for a year or so, as lenders shut out by CMHC turn to Genworth and Canada Guaranty.
   • That could allow private insurers to charge more for bulk insurance
   • Pretty soon the privates themselves could run out of insurance space.

The End Result

Mortgage insurance is a business. By participating in that business, the government takes risk, but it gets paid well for that risk. The government of Canada has earned $14+ billion in profits over the last decade from CMHC alone.

But the past is the past. Today we’re facing new realities (not the least of which is a hyperactive housing market). We're therefore compelled to ask:

• Which is the bigger risk, limiting portfolio insurance or staying our present course?
• Instead of curtailing bulk insurance, should underwriting criteria be tightened more?
• Or should the government simply force insurers to boost premiums (or levy surcharges of some sort), thus padding insurers’ buffers in the event of adverse default scenarios?

These are questions that policymakers have been asking themselves in private for a while now

Rob McLister, CMT

Top 26 Grants and Credits for BC Home Buyers

Check out this article to see if there may be grants or credits you're missing out on!

http://www.rebgv.org/sites/default/files/Top%2026%20Grants%20and%20Rebates%20-%20Updated%20January%2010,%202012.pdf

Canadian Economy

When Bank of Canada governor Mark Carney made his inaugural speech as head of the banking industry's global regulator on November 8 he said the world economy is getting hurt by a slump in liquidity, meaning banks are less willing or less able to lend money. And because global liquidity has fluctuated over the past five years, Carney said that Europe is already in a recession. He used the 2008 collapse of the U.S. investment bank Lehman Brothers as an example. The impact of that was that banks shied away from lending to both companies and consumers. That helped plunge the world economy into a major recession.

Clearly, if banks stop lending, consumers stop spending and businesses stop spending. For an economy to function, money needs to keep moving.

There has been talk recently that Carney might lower the prime interest rate to keep inflation in check. Carney has also said that the Canadian economy won't fully recover until well into 2013. Currently the prime rate is sitting at 1%. Inflation is approximately 2.7% and is predicted to slow to 1% in the second quarter of 2012. The Bank of Canada likes to keep the inflation rate between 1 and 3%. 

So what does that all mean for Canadians?

So far, the credit crunch hasn't hit Canada. While mortgage lending has tightened up a bit, banks are still lending money to businesses. The federal government has been making slight concessions to make sure Canada continues to grow:

• For example, on November 27, Finance Minister Jim Flaherty eliminated $32-million in manufacturing tariffs. This will allow businesses to lower their costs, enhance their ability to compete globally, which will help stimulate growth and job creation.
• On November 23, Mark Carney said he would stay flexible on interest rates. Despite the fact that inflation has been creeping higher, Carney said that although it may take longer to return inflation to target, being flexible with the rates will protect the country from any economic and/or financial shocks.
• The federal government is also moving ahead to change the laws that govern financial institutions, adding more oversight to protect consumers. "Canada has been ranked as having the soundest banks in the world by the World Economic Forum for four consecutive years," said Jim Flaherty, Minister of Finance in a statement released on November 23. "The Financial System Review Act will ensure our financial system continues to be secure for Canadians and a fundamental strength for our economy."

These changes likely won't have a direct impact on most Canadians but the after effects will. They include more jobs, higher profits for all businesses, access to low cost money for home buying and investing, stable housing markets and a strong and healthy banking system. 

All of this makes Canada a growing, stable economy that can weather short term fluctuations for a strong and prosperous future.

Penalty Calculations

"When a Certified Financial Planner (CFP) can’t figure out how to calculate his mortgage penalty, it’s got to be really tough for Joe Borrower.

Globe & Mail columnist Ted Rechtshaffen, a CFP, recently wrote about this very topic. He says: “My mortgage breakage cost truly is a mystery…I have read my mortgage contract…It can’t be found in the fine print.”

Like many banks, his (TD Bank) explains how to calculate its penalty, but people have to deduce the numbers to plug into the formula themselves.

Those numbers include:

1. The contracted interest rate (easy enough)
2. The posted rate at origination (not as easy)
3. The months left on the term (easy)
4. The relevant comparison rate (not as easy)
5. The current mortgage balance

To confirm these numbers, the borrower generally has to call his or her lender.

Wouldn’t it be nice, however, if you could log into your lender’s website and get this information with one click? It would, but lenders would much rather you call them for it. That way they can try to sell you a new mortgage.

A key point Rechtshaffen makes is that some lenders go out of their way to muddy the waters with respect to mortgage penalty calculations. They do that by:

• Not including certain inputs for calculating your penalty in their mortgage contracts (like the posted rate); and/or,
• Not telling you where to get the inputs on your own; and/or,
• Not clearly explaining (with examples) which term to use when determining yourcomparison rate; and/or,
• Writing penalty explanations in language that almost requires a law degree.

Penalty calculation shouldn’t be this cryptic. CAAMP says that 47% of people who refinance before maturity have to pay penalties. (It’s actually more than that if you include refis with blended rates [which have penalties built in].) So it’s not like this is some infrequent obscure need that borrowers have.

Lenders who believe they have their customers’ best interest at heart should provide a web page that clients can log into. It should provide an instant penalty quote, with a comprehensible explanation of how that penalty was calculated, showing the math.

RBC has a semi-workable solution with its penalty calculator. Unfortunately, you have to fill in the blanks yourself and few people will know what to enter for things like the “Discount off posted rate.”

In any event, one of the nice benefits of not getting a big bank mortgage is that your penalty is often based on discounted rates instead of posted rates. That often saves people hundreds or thousands of dollars. It’s even more meaningful given that most people break their five-year fixedterms in 3.5 to four years on average."

Rob McLister, CMT

CAAMP Consumer Survey Highlights

CAAMP just released its Fall Consumer Survey. Here are a few highlights from that report. To get your copy of the report visit CAAMP's website at www.caamp.org * The total value of owner-occupied housing in Canada is estimated at $3.017 trillion. Mortgages and lines of credit on these homes total $982 billion, leaving $2.035 trillion in home owners' equity. The equity is equal to 68% of the total value of the housing. * Among those who renewed or refinanced an existing mortgage during the past 12 months, 21% changed lenders and 79% remained with the same lender. The rate of switching has edged upwards - two years ago it was 12%. * Fixed rate mortgages remain most popular (60%). * Among borrowers who renewed, a large majority (78%) saw reductions, a smaller proportion (13%) saw their rates rise, and 9% had no change. * Based on the housing market forecasts, the volume of residential mortgage credit outstanding is forecast to continue expanding. Growth is forecast at about 7.7% during2011 ($80 billion) and 7.3% in 2012 ($81 billion). A preliminary look at 2013 suggests growth of 7.0% ($83 billion). Call or email Sharie Marie Mortgage Team today to discuss how your mortgage.

Is it time to lock into a fixed rate mortgage?

"It’s one of the most agonizing decisions homeowners make: Do you go fixed or variable? Mortgage, that is.

The decision could end up costing – or saving – big bucks on what is often the single biggest purchase many will make. Research shows that, in the past, a variable-rate mortgage has been cheaper than a fixed-rate one.

But today’s market is different from decades past in two big ways.

“The spread between fixed and variable rates is extremely low by historical standards. Moreover, we can no longer rely on a long-term down-trend in rates,” said Robert McLister, a Vancouver-based mortgage planner and editor of theCanadian Mortgage Trends blog. “Given all that, the historical advantage of variable is less applicable today.”

It can be confusing for homeowners. Both interest and short-term mortgage rates are sitting at rock-bottom lows. But inflation is the wild card here. Statistics Canada reported on Friday that the core inflation rate has climbed to 2.2 per cent – its highest level in nearly three years.

Given the uncertain global economic outlook, the U.S. central bank has signalled it will hold its benchmark rate at close to zero through to mid-2013. And even though Canada’s economy is not faring too badly, the Bank of Canada is expecting to keep its key rate steady at 1 per cent until well into 2012.

So how do you make the decision? Let’s compare the two mortgage products.

Variable mortgages, which are based on the prime rate set by the central bank, fluctuate alongside the prime rate. And with rates slated to move sideways for the near future, there are still arguably plenty of savings to be had.

With a fixed-rate mortgage, homeowners lock in their mortgage rate for a specific period of time, the most popular being five years. People with a fixed-rate mortgage often pay a small premium for the security of knowing that their payments will stay the same. And since rates can arguably only rise from their current lows, locking in seems like a good call.

“The difference between today’s variable rate, which is 2.7 per cent on the street, and a good fixed rate, something like 2.99 per cent for a four-year, is remarkably tight at 29 basis points,” Mr. McLister said. That is equal to about one rate hike.

It’s a small price to pay for “knowing that you won’t get skewered by rising rates.”

Moshe Milevsky, a finance professor at York University and the often-quoted author of mortgage studies showing that variables tend to outperform, says that because interest rates are so low, the amount people will save from choosing variable over fixed will be lower in the future.

Like most mortgage experts, he believes a person’s circumstances should dictate which mortgage they choose. The decision should also be part of a larger financial plan.

“For people who are making their first purchase with a large amount of debt, small down payment and big risk, I would say not to take on more risk by gambling on floating rates,” Mr. Milevsky wrote in an e-mail.

On the other hand, people who are renewing with a substantial amount of equity, have a strong personal balance sheet, income statement, and other assets to fall back on in the event of a crisis, can go floating, he said.

Mr. Milevsky also suggests checking out a hybrid mortgage, which is partially fixed and partially floating. “By diversifying your mortgage debt you can reduce some of the worry.”

The good news, according to Mr. McLister, is that today’s low interest rates are favourable for all mortgage shoppers. “This is a great time to get a mortgage, if you are in the market for one,” he said. “You are most likely not going to get burned, no matter which term you take.”

Mr. McLister says these are the top considerations for people struggling to decide:

1. Financials 
Because variable-rate mortgages entail more risk, you need to know whether you are financially sound. Borrowers should have “good I.D.E.A.S.” That means your: Income should be stable, Debt should be reasonable, Equity in your home should be roughly 15 per cent or more, Assets should give you liquidity if cash flow gets tight and Sensitivity to risk should be low.

2. Spreads 
When the difference – or spread – between fixed and variable rates gets tight, variables lose some advantage. When the spread is less than one percentage point and we’re near the bottom of an economic cycle, fixed mortgages often have a higher probability of outperforming. Today’s spread between a five-year fixed and a variable is an astonishingly low half a percentage point.

Odds are better than 50/50 that we’re near the bottom of a rate cycle.

3. Breaking early 
People often break their mortgages early, for reasons that include refinancing, selling, divorce, or just changing to a mortgage with a better rate. One bank source pegged the average duration of a five-year variable to be about 3.3 years. Lenders penalize you for getting out of a fixed mortgage early. Penalties on variables are generally three months interest, whereas fixed mortgages can sting you with horrendous interest rate differential penalties. If there’s a chance you’ll refinance or break your mortgage, a variable may cost you less.

4. Flexibility 
Variables give you the option of changing your mind and locking into a fixed rate for free, which is useful if interest rates are not likely to rise in the near future. The problem is, locking in can be expensive because you’re forced to time the market, which is tricky. Also, you’re stuck with the lender’s “conversion rate,” which is often a fifth to a half a percentage point above its best fixed rate.

5. Alternatives 
The five-year fixed and the variable are not the only options; take a peek at shorter fixed-terms. Today, for example, you can find two-year fixed rates at 2.49 per cent, whereas most variables are 2.7 to 2.75 per cent, or higher. You can also diversify rate risk with a hybrid mortgage – one that’s part fixed and part variable.

6. Comfort of knowing 
If you can secure a fixed mortgage at a good rate, there’s less need to monitor the interest rate market. You know exactly how much interest you’ll pay. Variable-rate borrowers, on the other hand, must ride the rate roller coaster and tolerate some anxiety."

-ROMA LUCIW Globe and Mail Update

Contact a Sharie Marie Mortgage Team Professional today to discuss your options