FIXED-RATE MORTGAGE NOW MORE ATTRACTIVE

Traditional thinking has been that young or first-time homebuyers should go with a long-term fixed-rate mortgage, while seasoned homeowners opt for a variable-rate mortgage.

But that thinking has been clouded in recent months

More than five years ago, Toronto's York University finance professor Moshe Milevsky did a study of five-year rolling interest rates during the previous 50 years, and showed that 88.6 per cent of the time, homeowners would have saved money having floating rate mortgages, which are tied to the rise and fall of bond yields, rather than fixed-rate mortgages, which are usually locked-in over a period of one to five years. The average saving was $22,000 on a $100,000 mortgage paid out over 15 years.

"At the time the bulk of mortgages in Canada were fixed-rate mortgages, yet the research showed you were probably better off with floating-rate mortgages in the long run," said Milevsky.

"That was when the yield curve was upwards sloping, so then the insurance premium for going fixed was pretty steep - you were really paying a premium to lock it in."

Today's flat bond yield curve, which means you've paying only one-half to one per cent extra to lock in a
rate long-term, makes fixed mortgage rates much more attractive than five years ago.

"I'd be inclined to go with a fixed-rate mortgage, and I would probably push it our further instead of shorter," said Kate Warne, Canadian market strategist with Edward Jones.

Not all experts agree, however.

"I think going variable has been the best approach over the past 10 years, and will continue to be the best approach over the next 10 years," said Benjamin Tal, senior economist with CIBC World Markets. "If you have had a variable rate since 2001, you have saved many thousands of dollars. I think for the next five years you will continue to benefit from a variable rate, but the difference will not be as significant."

Milevsky warns that your choice shouldn't be merely about dollars.

"What puzzles me about fixed or floating is that it's speculation. It's a risk management question. Short rates are easier to predict, floating rates I can control. Where will fixed rates be - I don't know where
the bond market's going to go.

"I have a floating-rate mortgage because I believe the research and I look at whether I need insurance that my mortgage won't go up. If I have a substantial down payment and can tolerate the fluctuations, I don't need the insurance. A new homeowner putting in the minimum amount might need the insurance and maybe they should go fixed. If you can only afford a floating-rate mortgage because it was cheaper, then maybe you don't belong in a house."

Apparently Canadians aren't huge risk takers.

"Variable rates in Australia and the U.K. make up about three-quarters of all mortgages," said RBC Financial Group chief economist Craig Wright. "In the U.S. and Canada we tend to be more risk-adverse, and we tend to have fixed mortgages (30 and 25 per cent in variable rate mortgages respectively)."

But Canadians are being tempted by a host of new mortgage products, including 40-year, interest-only, no down payment, and subprime mortgages that entice people with poor credit ratings into the housing market.

"Paying off loans slowing, especially non-deductible ones, is one of the biggest impediments to accumulating the retirement nest egg," said Vancouver financial advisor Adrian Mastracci.

Keys to reducing interest payments are the amortization period, namely the time over which you pay off the loan, plus the frequency of payments and pre-payment options.

Aurele Courcelles of Investors Group suggests you manage your mortgage annually by considering re-amortizing, increasing payments, making lump sum payments, or "blending and extending" your mortgage while long-term rates are low.

On a $100,000 mortgage at 6.0 per cent calculated semi-annually, you pay $137,400 in interest with a
35-year amortization, $91,900 in interest with a 25-year mortgage, and only $51,200 in interest over 15
years. Your monthly rates are $565, $640 and $840 respectively.

Also, making mortgage payments bi-weekly rather than monthly essentially gives you an extra monthly payment each year. It means you would pay off a $200,000, 25-year mortgage at 7.0 per cent nearly 4 1/2 years earlier and save $45,940 in interest. Weekly payments save you a bit more.

There are two key times to consider in a mortgage - if you pay it off in more than 25 years, you will pay more in interest than in principal, and with more than eight years left in your mortgage, more of you payment is going towards interest than principal.