I got a phone call one evening recently from a friendly representative of the bank that holds my mortgage. My five-year variable rate mortgage is not up until this coming December but she said the bank would waive all penalties and fees associated with breaking the mortgage if I would commit to a locked-in rate for four or five years.
I'm sure warning lights start flashing at the bank whenever my mortgage file pops up. I currently pay 2.25 per cent on the amount owing and for a long stretch during the dark days of the global financial meltdown I was paying a mere 1.5 per cent.
Come to think of it, if you consider nearly thirty per cent of all mortgages are variable rate according to the Canadian Association of Accredited Mortgage Professionals, there are probably a lot of warning lights flashing at the banks.
After a little bit of haggling — and me going through the usual routine of quoting the best deals from mortgage brokers and threatening to walk - this was the bank's final offer: A five-year, fixed mortgage rate of 3.99 per cent.
In dollars the 1.74 per cent rate increase would translate into about $65 a month more in interest payments. In return I would have the security of knowing that no matter how high interest rates rise in the next five years I will be snug in a rate of 3.99 per cent.
It seemed like a great deal … for the bank. If I locked in that week they would get an extra $65 a month from me right off the bat without having to provide any additional services. In return, they would take on a small risk of losing money in the longer term if their average borrowing costs ever exceeded 3.99 per cent. I say average because for it to be a total loss, future losses would need to exceed the $65 the bank gains each month while interest rates remain low.
I was confused, and when I get confused I talk to bond experts like Hank Cunningham at Odlum Brown. Variable rate mortgages are linked to the Bank of Canada benchmark rate, which has been one per cent for over a year and — at least in Hank's view - is expected to remain near one per cent well beyond my current mortgage term. The worse the global economy gets, the longer interest rates remain low to stimulate more borrowing and spending. The banks have a good idea of just how bad the global economy is because they have guys like Hank on staff.
On the global fixed income market, billions of dollars are made in the gap between the interest rate to borrow money and the rate that is charged to lend that money. That gap determines the bank's profit margin — and those big fat bonuses for the bank executives that come up with ideas like frightening borrowers into locking in at higher rates.
In fairness, a large rate increase on a big mortgage can be financially devastating for households on a tight budget - but fear can be a very effective sales pitch.
To figure out the gap for banks that provide mortgages you need to make certain assumptions. GMP Securities director of fixed income Joey Mack says a good apples-to-apples comparison between what the banks charge to lend to homeowners and what it pays to borrow money is the posted five-year fixed mortgage rate, versus the rate on the bank's 5-year covered bonds. The term "covered" implies there are assets, or collateral, to secure the loan. In the case of a mortgage the house and property are the collateral.
Joey did a little digging and found that this spring TD Bank issued (or borrowed) $3 billion U.S. of 5-year covered bonds with a payout of 1.5 per cent using its Canadian mortgage loans as collateral. That suggests the bank was borrowing at the same rate I was paying to borrow from the bank when my variable rate mortgage was 1.5 per cent — no gap, no profit - hence the alarm bells.
But if TD Bank can borrow money at 1.5 per cent and coax borrowers to lock in at its going 5-year posted fixed mortgage rate of 5.24 per cent, that gap is 3.74 per cent.
In the end I decided to maintain my variable rate mortgage at least until the end of the term.
I've gotten kudos from bond traders for beating the bank for a brief period of time, but a lender that can get 3.74 per cent on its comparable money in one of the most stagnant economies in modern history is enough to make any bond trader stand up and applaud.