Nobel Prize–winning U.S. economic egghead Paul Krugman got a lot of northern knickers in a knot some weeks ago when he suggested our real estate is doomed. Well, not exactly terminal, but he did lament our “overhang of private debt,” which makes house values “vulnerable to shock.”
What “shock” does he mean? Simple. Higher rates.
Most economists believe what most homeowners don’t: that interest rates will bloat. In fact, they already have. Lately, bond prices have been going down and yields up because the U.S. is in recovery mode. As the economic news gets better, we inch closer to the end of the fed bond-buying frenzy that’s kept the cost of money in the ditch.
It will take some time for interest rates to normalize, but there’s no doubt they will.
So how to protect yourself? Is it worth paying a premium for a few years in order to be protected later on? It’s a big choice if you happen to be buying now, or renewing.
Personally, I can’t imagine current rates holding, since they’ve led directly to record house prices and historic household debt — two big negatives for future growth and squarely in the crosshairs of the Bank of Canada. Clearly, there’s only one sane route to go. Here are the seven reasons why you should choose a 10-year mortgage.
First, rates will be up in five years, meaning higher mortgage payments on a house that’ll probably be worth less. Home loans have not been this inexpensive since Boomers were swimming up the birth canal. If you want protection against shock, this is it.
Second, what happens if you lose your job in the next decade? Get pregnant? Retire? Having a 10-year mortgage means your payments won’t change, giving you predictability in a volatile world.
Third, consider renewal risk. If you get a cheapo mortgage from an online lender you’ve never heard of before because it’s two-tenths of a point less, you have risk.
Fourth, 10-year money is ideal for investors. If you own a duplex or a sixplex or even a rented house, you can calculate cash flow and remove interest rate risk for a decade.
Fifth, you are not locked into a 10-year mortgage for 10 years. Thanks to the Canada Interest Act, all mortgages become open after five years. So if rates turn out to be lower in 2018, you can get out by paying the minimum penalty — three months. Sweet.
Sixth, given the fact that about a third of the wrinklies are now retiring with a mortgage, a 10-year mortgage protects them. Anyone on a fixed income, actually.
More important is the relative cheapness of 10-year money. Bankers will lock you up until 2023 now for 3.69 per cent, which is a scant 0.4 per cent more than their five-year offering. This is a gift and probably temporary.
You triumph financially, even without all the psychological and emotional stuff I referenced above.
So there you go.
Now worry about your tan.
Post City Magazines’ real estate columnist, Garth Turner, is an author, investment advisor and former MP.