Not a day goes by that I don’t get an inquiry from an applicant asking me: “What is best? Fixed? Variable? Open? Closed?”

I want to address this with you, because the “variable is best” mantra chanted by many brokers has been accepted as gospel truth by clients and realtors alike. However, there have been several points in time when variable is NOT best. For example, when rates are at the bottom of a rate cycle (right now). This is just like there are times when having bought Nortel stock would have been a bad thing (at the top).

Here is my analysis of variable rates, and the risks they presently pose:

Over the past 8-10 years, closed variable rate mortgages were available at AT LEAST at prime rate, but usually discounted below prime anywhere from prime – 0.25% to prime – 1.00% depending on applicant strength and lender policy. This has been the historical trend.

With prime at an all time low of 2.25%, the best discount in the market (as of today) is prime + 0.40%. Note that this is not a discount. It is, in fact, prime PLUS 0.40%. Variable rates are offered at a premium over prime in this market. Not three weeks ago, it was prime + 0.80% at most major banks. So the trend is that variable rate premiums are falling.

So, with the knowledge that in the last 12-18 months we’ve seen prime MINUS 0.90% go to prime PLUS 0.40% today, what is the best choice?

If a client takes a prime PLUS product in this market, they are stuck at a premium over prime rate, even if prime rate rises. With prime basically sitting on the basement floor, how much further can it fall? The Bank of Canada has indicated that prime will remain low until the end of the 2nd Quarter in 2010 (after the Olympics). With only upside in sight, it seems that a fixed 1 year term (convertible at any point into a longer term) is the way to go. This gives the client a guaranteed 1 year at the low rate of 2.90% with the protection that they can switch out to a fixed rate at any point in time.

“But variable rates are also convertible to fixed rates!” is the most common cry to my argument.

True, but there is nothing forcing the Bank of Canada to keep rates pinned down this low. Not two months ago they were talking about rate increases to stem what was the first signs of inflation, then a new set of economic data came out, and now they are talking about holding them low until 2nd quarter of 2010. The moral of this story is that economic indicators, like the weather, change frequently. A new piece of news could come out at any point in time indicating inflation is on the rise, and the Bank of Canada may increase prime rate despite their current claim of holding them low until 2010. Nothing is forcing them to hold rates low.

Lastly, the “conversion option” on variable mortgages is never as good as it sounds. I can get a client 3.59% today at a major lender in a 5 year fixed product, but the best rate that you can “convert” to from a variable is 3.89% (most banks it is 3.95% or higher). Clearly, the banks are taking bit of a profit when you convert and only offering their lowest rates to drive new business in the doors. True, the 1 year convertible faces this same problem, but you get a year’s worth of security for your trouble.

If you opt for a variable product today, where does this leave you

Stuck in a 5 year variable product, at a PREMIUM over prime rate (when historically they should be below prime rate and the premiums are currently falling) and your only option is to convert out to fixed rates that are very much higher than what is available in the market for a purchaser today.

My advice:

If you are a long term thinker, who likes a fixed budget, these 5 year rates are UNPRECEDENTED in Canadian history. Take a 5 year fixed rate, and you’ll be loving your security for the next 5 years. This is what I did on my personal mortgages.

If you don’t mind (or can afford) a bit of variability in your budget, take a 1 year term with convertibility rights (not all lenders offer this, so speak to me about solutions for your clients). Then you get a fixed low rate for at least 1 year, and can convert out to a longer term if you get a sniff that rates are on the rise.

If you have any questions or comments, or would like to know how to take advantage of these 1 year fixed rate convertible offers, don’t hesitate to contact me me at smith.rowan@mortgagecentre.com or 604-657-6775 (my cell). I make myself available to realtors and clients 7 days a week from 9am to 9pm or longer if necessary.

Oddly enough, with the world’s banking system in chaos in many countries, and Canada still forging onwards with little to no effects, people keep asking why the Canadian banks are solid? Why haven’t we in Canada suffered from the same downturn or banking liquidity crunch?

The short answer that I hear from most armchair economists (of which I consider myself), is “well Canadian banks are more tightely regulated.” I don’t really know if that is true or not, but I do know one thing for sure: Canadian banks are just that: Canadian banks, and this means they are conservative. Our banks do have several attributes which American banks do not, and these attributes are:

1. Nation-wide banks – this insulates financial institutions if a particular market in a particular city busts. The large banking system can aborb geographically localized down turns.

2. We don’t have tax deductible mortgages. Thus, a down payment on your home or against your mortgage is a form of tax free investment. This provides an incentive for homeowners to pay down their mortgages and NOT be overleveraged.

3. Mortgages over 80% LTV in Canada require insurance (often government backed).

4. Canadian banks have much higher capitalization requirements (funds on reserve) than other banks abroad.

5. Our mortgage in Canada (except Alberta) are not ones that you can walk away from. You can’t leave the bank with the keys and walk away Scott Free. If you get foreclosed on, and thouse is worth less than the mortgage, the banks in Canada will (and are legally allowed to) come after you for the shortfall.

So, there are some more regulations, but the nation-wide size, default insurance (without loop holes to get around it), and higher capitalization requirements for cash reserves, means that we are just typically Canadian: we are conservative. Bankers here never loaned out higher than 100% of a home’s value. We didn’t have the crazy “NINJA” loans (No Income No Job No Assets) that typified American Sub-Prime financing.

So, were we more tightly regulated? I don’t think that is really the case. Other nations have similar structures. The difference is just plain old conservatism: we didn’t wildly in the market upswing, and we won’t suffer as badly in a market downturn.

It’s kind of the way it’s supposed to be, isn’t it?