Historical article note: This article was originally published on 2018-10-19. Rates, policies, home prices, statistics, product names and qualification standards reflect the environment at that time and may have changed. This archive is for historical record and general education only. It is not mortgage approval, investment, legal or tax advice.
Is there a simple formula that tells us how to choose a mortgage interest rate? Yes, there are four basic principles: 1. Try to choose a fixed interest rate for your own home; 2. Choose a floating interest rate for an investment house; 3. Choose a long-term fixed interest rate during an interest rate increase cycle; 4. Choose a floating interest rate or a short-term fixed interest rate during an interest rate cut cycle. In addition to the four basic principles, what else should we pay attention to? 1. If you choose a floating interest rate, choose a bank with a larger prepayment amount; 2. Choose the longest repayment period, even if a shorter repayment period gives more interest rate concessions. Some readers feel that my article is relatively long and not suitable for today's busy urban rhythm. This time I will write a short article, and the core content ends here. The following is an explanation of the above point of view, and if you choose a floating interest rate, how to deal with the interest rate environment, readers can choose to read.
Let’s apply the four basic principles in practice and see if they are reasonable. Now is the period of interest rate hikes. I personally think that unless something big happens within 2 years, interest rates will continue to rise. If you want to buy your own home, what should you choose? By the way, follow the four basic principles to choose a 2-5 year fixed interest rate. What if you want to buy your own home? It is also a fixed interest rate for 2-5 years. What if you buy an investment property? It is recommended to choose between a 2-year fixed interest rate and a 5-year floating interest rate. There is an overlap here, which is a 2-year fixed interest rate. If it is an interest rate hike cycle and you are undecided about fixed or floating, and you are worried about whether to choose long-term or short-term, the safest solution is to choose a 2-year fixed interest rate, because it will not be wrong, just like no matter what the disease is, drinking more water will never go wrong.
Okay, let’s talk about the actual problem now: the interest rates keep increasing, and the last straw breaks the donkey pretending to be a camel... Every time the interest rate is increased by 1%, house prices will drop. Such claims have been rampant for a long time. Are they correct? When will the interest rate increase end? With all the hustle and bustle, can everyone still happily buy a house? Let me talk about my views on the trend of interest rates. Let me first state that this is not a prediction and does not represent any financial institution. I am just sharing some logic for analyzing the trend of interest rates. The fixed interest rate of a mortgage is a long-term interest rate, and the determining factor is the government bond yield. Many people don’t understand what bond yield means. Let me explain: The 5-year bond A issued 2 years ago had a face value of 100 yuan and a fixed interest rate of 2%. The bond B issued now has a face value of 100 yuan and a fixed interest rate of 3%. If you bought A 2 years ago and want to sell it now, you have to compete with B. Because the interest rate of 2% has been fixed, you have to sell it at a discount in the market, for example, 95 yuan. In short, the current bond yield is determined by the market, regardless of when the bond is issued and what the coupon rate is. The higher the bond yield on the market, the lower the price of A, which is why U.S. bonds have plummeted recently. Banks' fixed interest rate pricing for mortgage loans uses government bond yields as a reference for capital costs. As costs increase, loan interest rates will also increase. If bond yields keep rising, will mortgage rates keep rising? When will it end? When the yield on the 10-year U.S. Treasury bond reached 3.5%, it began to attract stock market funds and switched to bonds at a time of low inflation and low unemployment, thus causing turmoil in the bond market and stock market. At this time, the 5-year U.S. Treasury bond yield is 3%, the Canadian 5-year Treasury bond yield is 2.5%, and the Canadian 5-year mortgage fixed interest rate is about 3.7%. Let me tell you my conclusion: When the Canadian 5-year government bond yield reaches 3%, it will also cause turmoil in the stock and bond markets. Investors will make difficult choices between stocks and bonds, which will prevent bond yields from continuing to rise. The 5-year fixed interest rate by then should reach about 4.2% to 4.5%, provided that the current inflation rate of 2.8% remains unchanged. It is expected to reach this interest rate level in the second half of 2019. From another perspective, the real interest rate is the natural interest rate plus the inflation rate, and the natural interest rate is about 2%. The real interest rate is the cost of funds that a company is willing to borrow in order to operate and develop. If the inflation rate is stable at 2.8%, then the real interest rate should be around 4.8%, which is the best interest rate commercial enterprises can obtain, and mortgage loans are better loans with collateral, and the interest rate level should be slightly lower than the real interest rate. From the above analysis, I believe that the 5-year mortgage loan interest rate has risen to around 4.2%-4.5% and entered a stable period. From now on, banks still have room to raise interest rates by 0.5%.
When it comes to choosing your own home, especially your first home, peace of mind is the main goal when it comes to interest rate selection, especially for larger mortgages. If you definitely won’t change your home within 5 years, you can choose a 5-year fixed interest rate and sacrifice some interest expenses in exchange for a good night’s sleep in the next 5 years. It’s worth it. For investment housing, I recommend choosing between a 2-year fixed interest rate and a floating interest rate. The reason is that the tenant has a strong ability to resist risks and the interest is tax-deductible. Even if the interest rate increases, the actual loss will not be large. In addition, the monthly payment calculated with a lower interest rate will be of great help in applying for more investment housing loans in the future. In addition, short-term fixed interest rates and floating interest rates have low default penalty amounts, and you can make additional mortgages at any time to increase leverage.
When choosing a floating interest rate, choosing a bank is a very critical issue. For example, Bank A’s accelerated repayment policy is to repay 10% of the initial loan principal in advance every 12 months; Bank B allows accelerated repayment of 20% of the initial loan principal every calendar year. Then from October 2018 to October 2019, the maximum accelerated repayment amount allowed by Bank A is 10%, while the accelerated repayment amount allowed by Bank B is as high as 40%. When the central bank continues to raise interest rates, the allowed policy of accelerating repayment is very important. Every time the central bank raises interest rates by 0.25%, the borrower's accelerated principal repayment by 2.7% can offset the interest rate expenses caused by the interest rate increase. From July 2017 to July 2018, the central bank raised interest rates by a cumulative 1%, and 11% of the principal needs to be repaid in advance to eliminate the impact of the interest increase. In addition, each bank has different regulations on whether to require the borrower to increase the monthly payment midway if interest rates rise during the period after choosing a floating interest rate. Some banks only notify borrowers that the interest rate has increased, but keep the monthly payment unchanged, while some banks also notify borrowers that the monthly payment has also been increased due to the increase in interest rates. When choosing a floating interest rate, ask the bank two questions: the size of the prepayment amount, and whether the monthly payment will be forced to increase after the interest rate increases.
For borrowers who have chosen floating interest rates, here are some final suggestions: There are three ways to offset the impact of interest rate increases: 1. Choose to accelerate repayment, reduce principal, and reduce the increase in interest expenses caused by interest rate increases. 2. Converting a floating interest rate to a fixed interest rate. Most banks allow this and it is not considered a breach of contract. There is no penalty, but the borrower is usually required to convert to a fixed interest rate contract for a period longer than the remaining time of the original floating interest rate contract. For example, for a borrower with a 5-year floating interest rate, the original contract has been executed for 2 years and there are 3 years left. The bank allows conversion to a fixed interest rate contract with a term of more than 3 years. 3-year, 4-year, or 5-year fixed interest rates are acceptable without penalty. Friends who have chosen a floating interest rate, if it is an interest rate of P-1%, there is no need to switch to a fixed interest rate. Historically, P-1% is almost the best discount for floating interest rates. P minus 0.8 to 1, both are good. 3. If you have plenty of cash on hand, but the amount of accelerated repayment in advance is low and you cannot accelerate repayment in a large amount, you can choose to invest in financial assets such as floating-rate preferred stocks. For example, investing in preferred stocks issued by a company has a return rate of P+0.75%. As long as the central bank raises interest rates and P rises, the income will increase. This suggestion was given to me by one of my colleagues, Mr. Liu Yujie of BMO Nesbitt Burns Securities, because his investment clients rejoice whenever interest rates are raised, which is exactly the opposite of my clients. The relevant personal contact information has been removed.
For those who have bought an off-the-plan property, if the delivery period falls within the next two years, it is recommended to apply for a mortgage loan for the off-plan property. The bank has a builder capped rate mortgage, which is specially designed for off-the-plan property buyers. It is very helpful for situations where interest rates are rising. That is, if you apply for a loan now, the interest rate can be capped for two years, and the credit record report will only be reviewed once when applying.