December 16, 2020 | Lock ‘er up?

Days ago a blog dog reported being mocked by buddies for considering a ten-year-long mortgage term. The obvious advice here was to get new friends.

But wait. Does this make sense – now that a decade-long term is available for (wait for it)…1.99%?

Hmmm. It merits some serious noodling.

First, history has proven time and again that people who chose variable rates win. The cost of a home loan with a floating rate is generally less than one which is set for three or five years. Plus, over the last couple of decades we’ve had more deflation than inflation as well as economic potholes which have kept central banks hitting their brakes. So borrowers who went with a VRM saved interest costs and actually paid their principals down at a speedier rate.

But that was then. This is 2020. The year of lockdowns, quarantines, free govey money, recession, pandemic, mask fashion, curbsiding, working-in-undies, social distancing, Trump-busting, vax angst, burb lust, Zooming, crashing rents, bug stress and, yes, .99% mortgages. History is bunk, apparently.

In the last few months the big discount for a variable-rate loan relative to one nailed down for a few years has dissipated. So it just made sense to lock in for five years at 1.5%, or whatever ridiculous number your lender was offering. When rates are this low the bulk of every monthly cheque goes straight to paying off principal, so no need to make annual pre-payments or double up. As spelled out here recently, better to take the extra cash and invest it in a diversified portfolio – then pay down the mortgage upon renewal from investment gains. Diversification is good.

Now decade-long terms are crashing, too. That 1.99% rate is being offered by brokers and comes in below Tangerine’s 2.1% rate – an historic low.

The thing to remember about 10-year money is that all loans become open and fully payable after five years because of the Canada Interest Act (this is why we don’t have USA-type 30-year loans). As a result, if you take a decade-long mortgage make sure you don’t move, sell, croak or get divorced in the first 60 months. The mortgage break fee’s a killer. But after the five-year mark, this loan becomes open, so a homeowner can walk by paying a penalty equal to only three months of interest.

Now, what about the rate? A ten-year commitment at 2% costs more every year than a five-year term at 1.5%. Is it worth paying this additional amount for the first sixty months in order to have a 2% mortgage guaranteed for the next five years? In other words, will mortgage rates be materially higher in 2025 than they are now? If you think so, this makes sense. If not, go five.

Well, if you ask this pathetic (but muscular, low-cholesterol) blog for an opinion, there’s no hesitation. There’s but one direction for rates over the coming years. Up. If not there are worse things to worry about – like a complete vaccine failure, deep recession, and years of masked snouts.

But that’s not gonna happen.

Governments around the world have already spent almost $20 trillion on stimulus programs to counter the virus. More is flowing from Ottawa every day. The US is about to approve another almost-$1 trillion package. Central banks continue to snorfle up assets ($4 billion a week for the Bank of Canada). The combo of this fiscal and monetary stimulus – massive amounts of spending and debt – all but guarantees inflation and higher rates will emerge.

Meanwhile a world in lockdown – Toronto, LA, Madrid, Berlin, NYC – is stoking pent-up demand. Once the vax squishes the slimy little pathogen and herd immunity rides to the rescue, expect a torrent of consumer spending. More inflation. More rate pressure.

And look at the savings rate. As detailed here in recent days, government largesse has more than doubled the amount people are hoarding. Cash deposits are $170 billion ahead of normal levels, says CIBC. So much moolah, and nowhere to shop! This will end. More pressure.

Plus the vaccines. Soon there will be millions of doses available as the biggest inoculation in human history rolls out. Vaccine passports/aps will be required for travel, entertainment, shopping and employment. This is an unprecedented time, but also a triumph of science. As the vax flows, the virus will recede and as that occurs, global GDP will expand, pushing commodity prices higher, increasing inflation and augmenting rates.

It is inconceivable a Canadian mortgage will be 1.5% in 2025. You’ll be gonzo lucky to see 3% money. So a loan that runs until 2030 at just 2% could look very tasty. Borrow accordingly.

Garth Turner December 16th, 2020

Posted In: The Greater Fool

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