# Help me decide fixed or variable, bonds question + Poloz



## bluenote (Jul 27, 2012)

Hey guys

I'm choosing between 2.40 variable and 2.99 fixed for my mortgage right now. I don't want to be kept up at night about interest rates, but I don't want to be kept up at night by the sound of my loonies falling out of my pockets either 

I have a couple of questions, I hope someone here can help. (Forgive me quoting myself from elsewhere)

1) When Stephen Poloz says the 'todays *mortgage* rates are not normal' and 'new normal' for 'interest rates' is 3 - 4% in this interview, is he referring to the key rate, prime, or what with his 3- 4 % ? Listen really carefully.
Am I interpreting this correctly? Here's the video: (at the 5 minute mark)
http://www.ctvnews.ca/ctv-news-chann...?clipId=511509

2) After much frustration reading for and against analysts and such I decided maybe the bond market would give me some insight as to where the money thinks rates are going. I am a complete noob at reading this but, if I go here and look at the yields:
http://www.financialpost.com/markets/data/bonds-canadian.html

It seems to me that what that data says is that the bond markets anticipate at most about a quarterr to .4 percent rise in interest rates over a *5 year period*.

First of all, am I reading this right? 

I think this: http://www.bankofcanada.ca/rates/interest-rates/canadian-bonds/ tends to support what I'm reading.

But honestly I had to read backgrounders on how the bond markets work before I looked those up, so..

Hopefully somebody here can educate me. Thanks!


----------



## birdman (Feb 12, 2013)

Just a couple of comments and things for you to think about:
1. Interest rates go up and interest rates go down. In my opinion we are at or at least near the bottom of the cycle. This would suggest to me that rates are more likely to go up than down.
2. I believe some institutions will allow you to split the mortgage into 2 or perhaps more terms. In other words you may be able to have half your mtge on variable and half in say a 5 yr term.


----------



## HaroldCrump (Jun 10, 2009)

Bluenote, I would not try to time the bond market when it comes to taking out a mortgage for your home.

At this point in time, IMHO, the risk of going variable is not worth the reward.
The spread between variable and 5 yr. fixed rates are not that much.
5 yr. fixed rates from the 5 major banks are available at 2.89%.
The best variable rates I am hearing of are 2.40% i.e. P - 60 bps.

Keep in mind that the BOC can, and probably will, _cut_ rates if the oil-driven contraction continues.
But even a 25 bps cut will put the variable rate at 2.15%, where it was back in 2010 or so.


----------



## bluenote (Jul 27, 2012)

HaroldCrump said:


> Bluenote, I would not try to time the bond market when it comes to taking out a mortgage for your home.
> 
> At this point in time, IMHO, the risk of going variable is not worth the reward.
> The spread between variable and 5 yr. fixed rates are not that much.
> ...


I can definitely agree that the spread is small enough that it definitely is not a 'no brainer'. :/

From what I'm reading oil is going to stay low for a while. If you think a cut is coming, why do you say go fixed?


----------



## My Own Advisor (Sep 24, 2012)

I personally don't see rates going up 50 points over next few years but who really knows...I don't... 

If you want the "insurance" of fixed rates, then go for it. We did the same about 4 years ago. I didn't need to rate-watch because of it. 

Now, FWIW, when I renew, I'm tempted to go for 3-year-term, variable, in another 9-12 months from now with 15/15 or 20/20 prepayment options.

http://rates.ca/best-mortgage-rates/3-year/variable-closed


----------



## Cal (Jun 17, 2009)

Not sure where you are located, or who you normally deal with, but you might be able to beat 2.99% for a five year.

https://www.monstermortgage.ca/mortgage-rates/


----------



## GuzzlinGuinness (Nov 28, 2014)

Cal said:


> Not sure where you are located, or who you normally deal with, but you might be able to beat 2.99% for a five year.
> 
> https://www.monstermortgage.ca/mortgage-rates/


Additionally I'm pretty sure there are prime -.85 variable rates floating around through brokers like TrueNorth.. that's only Ontario that I've looked, so YMMV, but yes I imagine 2.99 fixed and 2.4 variable from one of the Big Banks is probably the best you are gonna get.


----------



## bluenote (Jul 27, 2012)

Thanks for weighing in gents. I'm noticing nobody wants to address the two specific questions though?
What was poloz saying exactly in that video?
Am I reading the bond numbers correctly?


----------



## OptsyEagle (Nov 29, 2009)

I AM NOT MAKING A PREDICTION. This is all about financial security.

If your finances cannot handle a 5% to 8% increase in interest rates then you need a fixed rate mortgage. To confirm this, just multiply your outstanding mortgage by 0.08 and divide by 12 and add that to your monthly mortgage payment. If this creates a big financial constraint you need a fixed mortgage.

As you will notice, I never mentioned anything about where future interest rates will be, what Poloz said, or what the weather might be in Tibet, a week from Thursday. Since one cannot know those things, I would not waste your time on them.


----------



## bluenote (Jul 27, 2012)

I'm not asking for predictions. 

1) I'm asking for somebody that understands this stuff better than I do, to tell me, am I reading those bond stats correctly? I think that's a very simple question and pretty factual. 

2) When poloz says 'todays mortgage rates are not normal' and 'the new normal' [...] 'interest rates will be 3 - 4 %' I'm not sure what this is relative to. 
Is he referring to todays mortgage rates , or the key rate, or something else? I notice that various sources seem to peg "the current rate" at a different level, I'm guessing based on how they generate the number - based on published rates, from what lenders, etc. From what I can see mortgages range from about 2.1 - ~4 % right now. So when he says rates will be 3 - 4 % what does he think today's rates are then?!

@Optsy: I'm not asking for a prediction as you would know if you had read the first post. I also don't need a primer on risk, or how to calculate my payments, or anything else that you did mention. But if you know anything about bonds, or can give me the CONTEXT to poloz's comments above I'd be happy to hear it.


----------



## My Own Advisor (Sep 24, 2012)

@bluenote,

1) When I open the FP article, I see coupons (meaning interest) paying around max. 4% now for Gov't of Canada bonds, up to 2019 or the next 5 years. This implies bonds yields are very low right now and earning potential from bonds is poor. Some provincial bonds seem to be paying more, and corporate, more risk, so higher interest there. 

That's my quick take.

2) When Poloz says 'todays mortgage rates are not normal' and 'the new normal' [...] 'interest rates will be 3 - 4 %' I'm not sure what this is relative to. 

I believe this is relative to historical bond yields and historical mortgage interest rates. With a quick search, you can see through the years today's rates are simply dirt cheap by comparison and this is not probably sustainable; meaning rates will go up but I suspect even Poloz has no idea when:

http://www.bankofcanada.ca/wp-content/uploads/2010/09/selected_historical_page57_58.pdf


----------



## Woz (Sep 5, 2013)

My interpretation of that interview is that Poloz is referring to the key rate.

The 2019/06/01 yield is 1.26%. The 2020/06/01 yield is 1.40%. If you’re using expectations theory to predict the future interest rate based on the yield curve then buying the 2019/06/01 bond and then purchasing a 1 year bond at maturity should give the same return as the 2020/06/01 bond. 

At maturity the 2019/06/01 bond would’ve yielded (1+1.26%)^4.5=1.0580. At maturity the 2020/01/06 bond would’ve yielded (1+1.40%)^5.5=1.0795. Therefore the 1 year bond yield in 2019 would need to be 1.0795/1.0580=1.0203 based on the current yield curve (i.e. rates would need to be 2.03% in 2019).

Note: expectations theory generally does a poor job of forecasting rates.


----------



## Mortgage u/w (Feb 6, 2014)

There is no one out there that can tell you where rates are going. The most they can do is predict and they are no more accurate that your or my prediction. Fact is, you should not be looking at fixed vs variable in the hopes that you beat the odds....that would be timing the market and we all know what happens when people try that.

I'm in the mortgage industry and am one who dislikes fixed rates. You may think the spread is thin between fixed and variable but I disagree. A spread of 0.60 is big. The prime rate usually increases in increments of no more than 0.25 so you need at least 3 hikes to be at a disadvantage with a variable. But just as the variable rate increases, so does the fixed rates. Needless to say, the variable rate has been constantly lower than the fixed the majority of the time. 

So what you SHOULD be looking at is PENALTY. The penalty is where the banks make their money. That 2.99% interest on your payment is petty cash. The penalty is what they are after. So how does this affect your choice? Simple. Going with stats, the average 5 year mortgage term is broken within the first 24 months of its term. Be it to refinance for renos, a divorce, sell home to buy another or pull out equity for investment, that 5 year mortgage is getting broken. Your penalty on a fixed term is a lot higher than a variable where the variable penalty is 3mth interest only.

If your concerned with rates going up......well, you'll be hit at some point whether you like it or not. So why not take advantage of the lowest rate possible knowing you can convert to fixed for free (in case rates jump to 10% overnight, right) or break the term at any time with minimal penalty.


----------



## OptsyEagle (Nov 29, 2009)

bluenote said:


> @Optsy: I'm not asking for a prediction as you would know if you had read the first post. I also don't need a primer on risk, or how to calculate my payments, or anything else that you did mention. But if you know anything about bonds, or can give me the CONTEXT to poloz's comments above I'd be happy to hear it.


Sorry for trying to help. I will stop doing that right now.


----------



## bluenote (Jul 27, 2012)

Woz said:


> My interpretation of that interview is that Poloz is referring to the key rate.


Thank you. This was my first interpretation, but it seems only you and I could notice the subtle distinction, and I don't commonly read or listen to this stuff so I wasn't sure about the common usage of how rates might be talked about. It's also supported by the fact the interviewer mentioned 1% as a consumer expectation, which also suggests to me that they are talking about the key rate at that point. I wasn't sure whether to assume the interviewer was an idiot or speaking hyperbolically, or whether they were both on the same page and just comparing different contexts.



Woz said:


> The 2019/06/01 yield is 1.26%. The 2020/06/01 yield is 1.40%. If you’re using expectations theory to predict the future interest rate based on the yield curve then buying the 2019/06/01 bond and then purchasing a 1 year bond at maturity should give the same return as the 2020/06/01 bond.


Thank you! I understand this to mean my interpretation was correct, that markets expectations is a rise that equates to an average over the full term to ~ .4% from day one.
(Or I've embarassed myself by misunderstanding twice in a row ..)



Woz said:


> At maturity the 2019/06/01 bond would’ve yielded (1+1.26%)^4.5=1.0580. At maturity the 2020/01/06 bond would’ve yielded (1+1.40%)^5.5=1.0795. Therefore the 1 year bond yield in 2019 would need to be 1.0795/1.0580=1.0203 based on the current yield curve (i.e. rates would need to be 2.03% in 2019).


I had to read this a few times and I think in the end this matched my mental picture of what the imaginary rate graph that would match those numbers would look like. Of course since we're talking averages, I guess there is other ways to get there. I'm less comfortable assuming I will know the exact rate at the end of the 4 year term though even based on the difference between 2020 and 2019. I would have to assume less certainty as the terms got further out. 




Woz said:


> Note: expectations theory generally does a poor job of forecasting rates.



Since I'm only concerned with the average effective rate, doesn't this become a slightly better predictor? [With the built-in caveat that markets are obviously wrong about predictions all the time]

Thanks so much for the indepth analysis!


----------



## bluenote (Jul 27, 2012)

Mortgage u/w said:


> There is no one out there that can tell you where rates are going. The most they can do is predict and they are no more accurate that your or my prediction. Fact is, you should not be looking at fixed vs variable in the hopes that you beat the odds....that would be timing the market and we all know what happens when people try that.
> 
> I'm in the mortgage industry and am one who dislikes fixed rates. You may think the spread is thin between fixed and variable but I disagree. A spread of 0.60 is big. The prime rate usually increases in increments of no more than 0.25 so you need at least 3 hikes to be at a disadvantage with a variable. But just as the variable rate increases, so does the fixed rates. Needless to say, the variable rate has been constantly lower than the fixed the majority of the time.
> 
> ...


Thank you, you've got some good info there. I was surprised to learn about the difference in penalties when I looked into this, and while I do have to figure that in, it's only in the sense of a 'worst case' refi as affects my leverage converting from variable to fixed at that time with the lender. While I do not doubt your 24 month stat, I do think that Im in the best position to predict the odds of whether I would have to break a fixed or not. Of all the uncertainties I have the highest confidence in that one, heh.

When you say 'you're going to get hit with it at some point' I think that may be oversimplifying just a little. That 'at some point' can make a fairly big difference.


----------



## bluenote (Jul 27, 2012)

OptsyEagle said:


> Sorry for trying to help. I will stop doing that right now.


I'm happy to receive help. Just not snarky sarcasm. I'm still very open to what you have to say.


----------



## OptsyEagle (Nov 29, 2009)

bluenote said:


> I'm happy to receive help. Just not snarky sarcasm. I'm still very open to what you have to say.


You didn't seem very open for it to me. The only one being snarky was you.


----------



## bluenote (Jul 27, 2012)

I'm going to go out on a limb here and post some of my suppositions. Obviously caveats apply up and down, but I figure you guys will have a bit of fun laughing.
Particularily I'm not trying to say that any one entity knows for sure what's going to happen, I'm just trying to build a picture that includes info from sources that I think may have better info than I do.

Here are my provisional current conclusions:

1) Poloz thinks the key rate will rise to 3 - 4 % *eventually* [ no info on how long it takes to get there though ]

2) I *infer* Poloz says rates are extremely unlikely to go up more than 2% in a 5 year term. [puts a possible cap on my worst case scenario calculations ]
For anybody interested, this is also in the video, he says in reference to the damage sudden changes might have, that 'banks are testing people on a 2% rate increase so that when it comes time for them to renew they can still afford their payments'. Not word for word. I assume what this actually means is that unless forced to do so changes wouldnt be more than 1% in a term.

3) The bond markets (until Woz corrects me) appear to be predicting an effective *average* of +.4% over 5 years Note that I assume this looks like being 2.8 for me, starting tomorrow until the end of term. I'm not suggesting rates will be 2.8 at the end of that term.

4) What my actual interpretation of the larger picture is, rates are going to stay low for longer than anyone expects, that a rise will be further off, and will not go up suddenly, and not many in succession. That it would actually be profitable for me to go variable. I have to balance this one against my newbishness, and my slight confirmation bias since that would be a positive outcome for me. So I'm discounting this pretty much completely from my decision making.

Taking all that into account, I'm probably heading to fixed right now. Unless I'm convinced that in the case of converting, I would be offered a very competitive rate. So far I admit I am not properly educated about this aspect aside from that the penalty on a refi would be low.

Because:

1) Prime ain't going down any/much further even if BOC does a rate cut. 
2) If i take the spread and compare it to a .4% average over the term [bond market prediction] what I stand to actually gain is not all that large. [.19%]
3) I have to take my own gut feel with a big grain of salt. There's a LOT of talk about rates rising, and it wouldnt take too many to erase any benefits to me.

Ok, laugh away gents


----------



## My Own Advisor (Sep 24, 2012)

No laughing. You need to do what you feel is best in the end.


----------



## Woz (Sep 5, 2013)

I think you’ve got it. I was a bit thrown because of your initial comment: “It seems to me that what that data says is that the bond markets anticipate at most about a quarterr to .4 percent rise in interest rates over a *5 year period*.”

The bond market is predicting that rates will rise 1.03% over 5 years, but that averaged over a 5 year period it’d be a 0.4% increase.

With regards to its accuracy … I have no clue. Average rate is probably a bit more accurate because a small change in the average rate would translate into a large change in the final rate. However, the final rate only has one prediction, the final rate, whereas the average rate contains both a prediction on the final rate and the timing of the increases.


----------



## Woz (Sep 5, 2013)

One source of information that you might find interesting is the FOMC meetings (US interest rates).

http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20141217.pdf

p4 shows the Federal Reserve’s expectation for US interest rates for the next 3 years. 

Pure speculation, but my personal expectation is that Canada will probably lag the US by a year in raising rates and that the federal reserve will raise rates more slowly than they’re currently forecasting.


----------



## Siwash (Sep 1, 2013)

I would NEVER get a fixed rate mortgage... unless you like to make banks richer... rates aren't going anywhere... and if they creep up, you can lock in..


I don't get why most Cdn are fixated on fixed rates... pardon the pun


----------



## Siwash (Sep 1, 2013)

And if you're getting a 2.4% variable, you're getting ripped off..

I just got a 2.15% at Butler... has all the same bells and whistles as the banks... 

The diff b/w 2.15 and 2.99 over 5 years is huge... thousands of dollars.. people are giving you bad advice here...


Rates ain't going anywhere.... and if they do go up, it'll be a few years down the road and probably in such tiny increments, you won't feel it.. in the meantime, you've saved a lot of money 

Remember, most lenders will allow you to lock in if rates start going up..


----------



## My Own Advisor (Sep 24, 2012)

I think if you KNOW or don't intend to move for 3-5 years, AND, the price differential between variable and fixed is less than 25 points, it might make sense for many folks - going fixed, because this is some small insurance any interest rates going up.

That said Siwash, I'm looking forward to going variable with my next mortgage term, likely 3-year variable. It will be important to me I can also lock-in my rate if it goes up during that period.


----------



## birdman (Feb 12, 2013)

Having spent a lifetime in the financial services industry I thought I would make a couple of comments that have been made on this thread. 
Firstly, comments to the effect "I would never go fixed rate" has certainly been the right call over the past years but in the mid 1980's prime rate hit 22.75%. I don't believe VRM's were generally available at that time and if I recall correctly the best mortgage rate was around 17.5% for 6 mos. Most people were renewing maturing 9 or 19% mortgages at 17.5%! I bet those people sure wished they were in a longer term fixed rate! Numerous, and I mean numerous people including personal friends were forced to sell their homes at deflated prices as they could not make their payments. House values (in Vancouver) dropped 25-50%. Hope this doesn't happen again but it is just something that I think people should be aware of and can they stand "interest rate shock" and if so to what extent. I'm not suggesting people take fixed term and rate mtges. but just to understand what could happen, albeit unlikely in my opinion. 
Secondly, in regards to comments that F/I's make $$ on prepayment penalties and fixed rate term mortgages is not necessarily so. Banks operate on the margin between cost of deposits and income from loans and mortgages. Also, maturities are "matched or locked in" to protect these margins. For example, a 5 yr mortgage at say 3.25% is funded by a 5 year term deposit at lets say 2% and the margin is 1.25%. In the case of a VRM ar say 2.4%, this is funded by a shorter dated term deposit or perhaps an investment savings account at say 1.15% for a spread of 1.25%. So, the margin a F/I makes on a mortgage is 1.25%, Yes, there are also 0 interest deposits on chequing accounts, etc which are also used to fund mortgages, Prime plus demand loans, etc at increased margins but for mtges F/I's were pretty content if they could make a 1.25% spread. This whole asset liability management is much more complicated but starts with the foregoing.
Now, in regards to prepayment penalties "What happens if a F/I has a 3.25% 5 yr mortgage funded by a 2% deposit and rates go down by 1% a year later? The bank has no interest rate risk except that if the owner wants to sell his home and payout the mortgage. If they allowed this (without a penalty) they would be left with a 2% deposit with 4 yrs remaining on the term and could only match it off with a 4 year mortgage at a lower rate, probably 2.25% using the above example. In this case they would only have a margin of .25%. The prepayment penalty was designed to offset this. This is where the clause "interest rate differential" came into play.
Again, the process is much more involved that what is shown in the above example and the process is dynamic in that it changes every day. The process involves using interest rate swaps, forward contracts, modelling, and risk and is talked about in the notes included in annual reports of the Banks.
Anyways, pretty boring stuff but thought I would just post my comments which I have done previously on a different thread.


----------



## RBull (Jan 20, 2013)

^When I was reading this thread earlier I was thinking of much the same things as you've stated about rates and history. 

Back when I had a mortgage for a couple of homes over a 10 year period mortgage rates ranged 9-12%, probably averaging 10%+ IIRC. There weren't the number of options regarding mortgages then, compared to today. 

This board seems to have a lot of younger homeowners and investors that probably have a hard time appreciating MUCH higher costs of leveraged purchases. Their stock market experience may also be limited mostly to this spectacular bull run, and likely have not had a significant portfolio that took large losses. 

This may be reason why we see words like never and an appetite to assume debt and rate risk.


----------



## birdman (Feb 12, 2013)

RBull I think you are right on and hit the nail on the head. Clearly, in the early to mid eighties nobody ever dreamed of the prime rate being 22.75% and at say @ Prime + 2% for a loan you were paying 25% PA. No wonder we had runaway inflation. Also, if rates do go up its hard to lock in as they do not necessarily go up in tandem. Your 2.5% rate will increase to 3% but the 5 year rate would go to, perhaps 7%. Then what do you? Most people took the 3% rate but then it would go to 4% and the 5 yr would go to perhaps 9%. In other words the yield curve steepens. In Sept of 1981 5 yr bond yields peaked at almost 19%. Then later on you had an inverse yield curve when long term rates were lower than short term rates.


----------



## RBull (Jan 20, 2013)

^Thanks. I should have said a VORACIOUS APPETITE. 

You are presenting some valuable insight and food for thought for those currently with debt or those considering it. I was lucky that it was the mid 80's with my first house and rates had crashed to a deep discount rate of only 12%!


----------



## bluenote (Jul 27, 2012)

frase said:


> RBull I think you are right on and hit the nail on the head. Clearly, in the early to mid eighties nobody ever dreamed of the prime rate being 22.75% and at say @ Prime + 2% for a loan you were paying 25% PA. No wonder we had runaway inflation. Also, if rates do go up its hard to lock in as they do not necessarily go up in tandem. Your 2.5% rate will increase to 3% but the 5 year rate would go to, perhaps 7%. Then what do you? Most people took the 3% rate but then it would go to 4% and the 5 yr would go to perhaps 9%. In other words the yield curve steepens. In Sept of 1981 5 yr bond yields peaked at almost 19%. Then later on you had an inverse yield curve when long term rates were lower than short term rates.


This is something that I found hard to quantify, but was on my mind. I'm not aware personally or know anyone that was, in a situation where, rates are going up and now we want to convert from variable to fixed -- what fixed rate would be available, even in a low-penalty situation of 3 months interest, suddenly we're in a situation of do we bite the bullet now, or wait and hope.

Some great info and perspectives in this threads, thanks to everyone who contributed.

EDIT: Oh, and just for anyone curious - yes I was fully aware of the cost differences. My primary tool for benchmarking my decisions on this was a spreadsheet with interest costs / equity differential for all the scenarios, best case, worst case, most likely case. I didn't find it that compelling that if EVERYTHING went my way for 5 years (ie; not a single increase) I was going to come out ahead ~ $10k or so variable. In 5 years time is it likely that if I come back to this and re-do the calculation that I will have left at least some of that on the table? Probably. But I also ran very possible scenarios that would have easily cost me $20 - $40k more. Personally I don't have that much confidence in my ability to predict these things, not having tonnes of experience at it.


----------



## bluenote (Jul 27, 2012)

RBull said:


> ^Thanks. I should have said a VORACIOUS APPETITE.
> 
> You are presenting some valuable insight and food for thought for those currently with debt or those considering it. I was lucky that it was the mid 80's with my first house and rates had crashed to a deep discount rate of only 12%!


This is something that was on my mind a lot too. Everyone around me going variable and trumpeting it the most were the ones with the most to lose were things to go south. But in a market like the one we're in, everybody's a genius until much much later if bad times appear.


----------

