Fixed-rate mortgages losing market share

By Doug Watt | October 28, 2004 | Last updated on October 28, 2004
3 min read

(October 28, 2004) Canadians still prefer the safety and security of a fixed-rate mortgage, but variable-rate mortgages are gaining in popularity, a new survey released today by BMO Financial Group suggests.

The study found that 68% of homeowners held a fixed interest-rate mortgage, while 22% favoured a variable, or floating-rate, mortgage.

BMO vice-president Maria Racanelli says the survey results may be surprising considering the current low-rate environment and the numerous variable-rate mortgage products now available.

“However, it does represent a significant shift in consumer behaviour, because if we had done this survey five years ago, the percentage of homeowners who held a fixed-rate mortgage would probably have been in the 90% range,” she said.

Younger homeowners (aged 18-34) were slightly more likely to favour fixed rate at 70%, compared to 68% in the 35-54 age bracket. Older homeowners (55-plus) were least likely to favour fixed rates, at 63%.

BMO also asked Canadians about the future direction of interest rates. Sixty per cent said they thought rates would rise over the next six months, but only 8% believed the increase would be significant. Twenty-seven per cent thought rates would likely stay close to where they are today.

Moshe Milevsky, associate professor of finance at the Schulich School of Business at Toronto’s York University, has written extensively about mortgages. He points out that although most Canadians have a mortgage, they’re faced with a supermarket of options on the product side, but don’t have a clear understanding of how interest rates work.

Milevsky notes that when the Bank of Canada raises its key overnight lending rate, variable mortgage rates also rise, since they’re based on the bank prime rate. But it’s conceivable that fixed-rate mortgage rates could decline on the very same day, since they’re tied to the bond market.

“But when Canadians hear interest rates are going up, they assume all rates as rising,” he said last week at the Advisor Forum in Halifax.

It’s up to advisors to explain that to clients and to apply asset allocation models to mortgages, just like investments. “Similar to investments, there’s a risk return trade-off when it comes to mortgages,” he says. “How does this fit with the rest of your portfolio?”

Milevsky studied mortgage rates over a 50-year period and found that 88% of the time, the variable-rate option was less costly than fixed. (For more on Milevsky’s studies on mortgage rates, see the August 2004 edition of Advisor’s Edge magazine.)

But he says that doesn’t mean variable-rate mortgages are the right choice for all clients. “We are faced here with another risk-return decision that should depend on your client’s risk preferences.”

“Focus on risk management and take a look at your client’s balance sheet,” he advises. “Do not speculate on interest rates, and don’t try to forecast what the yield curve will look like; it’s difficult to outsmart the bond market.”

For example, he suggests that first-time homebuyers on a tight budget with little money down should lock in a fixed rate to minimize the fluctuations of their liability. “They can’t afford to take the risk,” Milevsky states.

At the other end of the spectrum, seasoned homebuyers with a strong personal balance sheet can afford to take the risk of variable rates.

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Moshe Milevsky is speaking at upcoming Advisor Forum conferences in Calgary, Vancouver and Toronto. For more information on when Advisor Forum comes to a city near you, please click here.

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Doug Watt