This year the Bank of Canada has raised interest rates once for a total of a 20 basis points or a 0.20 percent increase. Is the Central Bank going to raise interest rates again and if so, when? This is an important question, since prospective Buyers may be putting off their real estate purchases for a variety of reasons: kids still in school, better to move in good weather, an expected salary increase. But then, does it make sense to wait? The answer is: it depends. Let us first take a look at the historical charts. For the sake of our calculations, let us consider a 5-year term mortgage rate, which is the benchmark mortgage most consumers will take on at the time of purchase. An additional note to readers: this example is based on Canadian mortgages, which typically use compound interest. The principle, however, is equally applicable to American mortgages, with interest amortized on a straight line over the life of the loan. CHARTERED BANK ADMINISTERED INTEREST RATES [ [ June 1990 ................. 14.25 [ ] June 1991 ................. 11.25 [ ] June 1992 ................. 9.63 [ ] June 1993 ................. 8.95 [ ] June 1994 ................. 10.75 [ ] June 1995 ................. 8.63 [ ] June 1996 ................. 8.50 [ ] June 1997 ................. 7.00 [ ] June 1998 ................. 6.95 [ ] June 1999 ................. 7.70 [ ] June 2000 ................. 8.45 [ ] June 2001 ................. 7.75 [ ] June 2002 ................. 7.25 [ ] June 2003 ................. 5.80 [ ] June 2004 ................. 6.70 [ ] June 2005 ................. 6.05 [ ] March 2006 .............. 6.45 Notes: all rates above are expressed with semi-annual compounding The general rule of thumb is that if you can afford to make the monthly payment today, you should go ahead, lock in and buy a home. Especially these days that mortgage rates are on the rise but still 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 down-payment, 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 6.45 percent, the monthly mortgage payment will be $2,667.18, inclusive of interest and principal re-payment. If you wait for a year and rates increase by 50 basis points to 6.95 percent, the monthly payment will be $2,789.33. That's a difference of $122.15 per month, which amounts to a yearly increase of $1,465.80 in your cash outlays or a whopping $36,645 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 |
