Friday, May 13, 2005


Let me help you save CAD $36,090 !

This year the Bank of Canada has raised interest rates once and then lowered them once for a total of a 20 basis points reduction or 0.20 percent. Is the central bank going to raise interest rates again or is it going to lower them? This is an important question, since prospective Buyers may be waiting for additional rate cuts. But then, does it make sense to wait? The answer is: it depends.
Let's first take a look at the historical charts. For the sake of our calculations, let's consider a 5-year term mortgage rate, which is the benchmark mortgage most consumers will take on at the time of purchase.

Notes: all rates above are expressed with semi-annual compounding and refer to 5-year closed mortgages.

The general rule of thumb is that if you can afford to make the monthly payment today, then you should go ahead, lock in and buy a home. Especially these days that mortgage rates are low from a historic perspective - for example from the early 1990's when double-digit mortgage rates were commonplace. Buyers who are uncertain about rates should consider locking in for three to five years. This will offer them peace of mind, so they do not have to worry about the ups and downs. This added security, however, comes at an extra cost. A study conducted by Canada Mortgage Housing Corporation (CMHC) has shown that in the 1980's and 1990's borrowers would have saved money by choosing a one-year term mortgage and renewing every year, rather than locking into a 5-year term.

If consumers do not lock in and interest rates increase, say, by 50 basis points, what will be the additional cost? Let's say you are about to buy a CAD $550,000 house with a $150,000 downpayment, and that you are considering taking up a CAD $400,000 mortgage for a 5-year term and amortized over twenty-five years. For a 5-year term at the current posted rate of 6.05 percent, the monthly mortgage payment will be $2,571.13, inclusive of interest and principal re-payment. If you wait for a year and rates increase by 50 basis points to 6.55 percent, the monthly payment will be $2,691.43. That's a difference of $120.30 per month which amounts to a yearly increase of $1,443.60 in your cash outlays or a whopping $36,090 for the life of a mortgage over a 25-year amortization period. This is a saving you can hardly afford to miss out.

Luigi Frascati

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