Toronto Star, April 20, 2002 How to succeed at mortgage-rate roulette Arise in mortgage interest rates this week has some consumers wondering whether to take a low floating rate or lock in a higher fixed rate. It's a perennial question, but it deserves a thorough analysis. So, with some help, we are going to walk you through a few scenarios. Variable-rate mortgages tied to the banks' prime lending rate are still temptingly low -- 4 per cent or less with the various discounts now available. A colleague brave enough to play goalie in hockey has just decided to take a floating rate. He negotiated a deal with the Canadian Imperial Bank of Commerce that would see his mortgage rate remain at three-quarters of a percentage point less than the prime rate for the next five years. He will start by paying an annual rate of 3.25 per cent, which will allow him to free up some extra cash or pay off principal quicker. The best five-year rate that a mortgage broker could find him yesterday was 6.25 per cent, a whopping difference of $160 a month for every $100,000 of principal amortized over 20 years. What's not known is how high prime rate -- and hence my colleague's mortgage rate -will rise as the hoped-for recovery in the economy gains momentum. Economists disagree about whether the Bank of Canada moved too quickly when it raised its overnight lending rate a quarter percentage point this week, pushing up consumer and business loan rates. Ted Carmichael of J.P. Morgan Securities Canada is one who favours an early but gradual increase in rates. This, he argues, will help avert price inflation and spare us from larger increases later. He is projecting that the central bank's bellwether overnight rate will rise another 1.75 percentage points to 4 per cent by next June. That rate, says Carmichael, would neither stimulate nor retard the growth of the economy. If he proves to be right -- a difficult task -- then the prime lending rate would peak at 5.75 per cent. In that scenario, my friend would be a big winner. He would never pay as much per month as he would if he locked in now for five years. But what if the prime rate soars nearly as high as the 9.75 per cent that we saw seven years ago in order to bring inflation down from 2.2 per cent that year to 1.6 per cent the next year. With the help of Moshe Ayre Milevsky, associate professor of finance at York University's Schulich School of Business, we constructed a simplified scenario. Say someone paid the prime rate to borrow $100,000 with an amortization schedule of 20 years, and the rate rose by 1 percentage point every six months to a peak of 9 per cent before sliding back to 5.75 per cent. The total cost over a five-year period would be $42,637. Surprisingly, this cost would be $923 less than for someone who locked in at 6.25 per cent for the entire period -- a reassuring finding for floaters like my friend th goalie. "The longer that floating rates stay below the locked-in rates, the higher rates have to rise and the longer they must stay there for you to just break even," says Roman Fedchyshyn, president of Manulife Bank of Canada. But the borrower would have to be prepared to see his or her monthly payment rise from $604.25 during the first six month to $856.35 at the peak. That difference of $252 a month could be too much for some households to absorb unless they banked enough of their savings in the early months to get over the hump. Mileysky found in an earlier study for Manulife Financial Corp. that during the past 50 years, a person would have done better borrowing at prime than taking a five-year mortgage 88.6 per cent of the time. Yet even he cautions that first-time home buyers and others with tight house-hold budgets should be careful about riding the interest curve. A floating-rate mortgage is not for the faint of heart, or for the financially challenged. Like a hokey goalie you need to have some extra padding. For those who can afford to float, though, many lenders are now offering discounts off the prime rate, cash back or additional services such as the Manulife One account that's a combination mortgage, line of credit and high-interest savings account. CIBC's Better Than Prime Mortgage will cut 1.01 percentage points off prime for nine months, and 0.25 points for the next 51 months. But, as my friend discovered, you can negotiate a better deal ________________________________________________________________________ Floating rate Cost over five years of a $100,000 variable rate mortgage amortized over 20 years, if rate tied to prime rises 1 percentage point every six months before declining. Month 1-6 6 - 12 12 - 18 18 -24 24 - 30 30 - 36 36 - 42 42 - 48 48 - 54 54 -60 Total Interest Rate 4% 5 6 7 8 9 8 7 6 5.75 Monthly Cost $604.25 655.98 707.42 761.92 807.94 856.35 797.52 742.99 692.68 679.11 Six-month Cost $3,625.50 3,935.88 4,244.52 4,571.52 4,847.64 3,938.10 4,785.12 4,457.94 4,156.08 4,074.66 $42,636.96