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- Aug 30, 2007
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The Bank of Canada raised the overnight target rate ("wholesale prime rate"), as expected, by 0.25% to 1% earlier this week. Banks tack on a generous 220% profit margin so the retail prime rate is now 3.2% (although it used to be 3% when BofC's overnight rate was 1% a few years ago).
Banks are like clothing or shoe stores: big margin between wholesale and retail price, plus some popular items have bigger margins than others. Like clothing retailer they also pad some loans more than others. Why ? Because they can !
As a further two hikes by 0.25% each are expected in 2018, the question is: to lock in a 5 year rate or go shorter or variable ?
I'd say: Never EVER lock in or go 5 years.
Four reasons:
1) Banks don't know rates 5 years out so they pad this popular rate with the biggest risk premium.
2) 5 years are most popular with non-investors such as entry level and even more mature home owners and as such banks pad this rate with the biggest cushion.
3) variable rates are always cheaper, on average
4) 2-3 year rates are always quite a bit cheaper than 5 year terms
Do you buy new shoes or a new shirt if they are 20% more ? A 5 year rate is often 0.4 to 0.6% more than a 2 year rate of say 2.5%. 0.5% over 2.5% is 20% more !
Who cares you might say. What's the difference of say 0.4% on a $400,000 loan ? $1600/year or over $130/month. That is one fancy or two basic dinners for two A MONTH .. on the bank !
The ONLY reason to go 5 years is when you expect a major drop in income in 2-3 years but most banks auto-refinance at the then lower mortgage balance by offering you a choice, so while in theory they can call the mortgage due in three years that is very very rare.
I usually go with two and sometimes three year mortgages when re-financing my several houses or condos I own as the rates and the payout penalty are far lower.
Banks are like clothing or shoe stores: big margin between wholesale and retail price, plus some popular items have bigger margins than others. Like clothing retailer they also pad some loans more than others. Why ? Because they can !
As a further two hikes by 0.25% each are expected in 2018, the question is: to lock in a 5 year rate or go shorter or variable ?
I'd say: Never EVER lock in or go 5 years.
Four reasons:
1) Banks don't know rates 5 years out so they pad this popular rate with the biggest risk premium.
2) 5 years are most popular with non-investors such as entry level and even more mature home owners and as such banks pad this rate with the biggest cushion.
3) variable rates are always cheaper, on average
4) 2-3 year rates are always quite a bit cheaper than 5 year terms
Do you buy new shoes or a new shirt if they are 20% more ? A 5 year rate is often 0.4 to 0.6% more than a 2 year rate of say 2.5%. 0.5% over 2.5% is 20% more !
Who cares you might say. What's the difference of say 0.4% on a $400,000 loan ? $1600/year or over $130/month. That is one fancy or two basic dinners for two A MONTH .. on the bank !
The ONLY reason to go 5 years is when you expect a major drop in income in 2-3 years but most banks auto-refinance at the then lower mortgage balance by offering you a choice, so while in theory they can call the mortgage due in three years that is very very rare.
I usually go with two and sometimes three year mortgages when re-financing my several houses or condos I own as the rates and the payout penalty are far lower.
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