The Bank of Montreal slashed 5-year mortgage rates today to a low of 2.99%. It looks like our Canadian banks are thinking about starting a bidding war to gain your business and boost their mortgage portfolios. Before you jump at these ultra low rates, consider the long term impact on your budget and household debt levels.
Banks need to lend money to make money. Having just collected deposits with the completion of RRSP season, they have now turned their collective marketing efforts to loaning out all that cash. Basic laws of supply and demand say if they have more to sell, they need to lower the price to keep, and hopefully gain more, business. BMO started the ball rolling today with their most recent interest rate reduction. The banks want to build their portfolios before interest rates begin to rise. They know most people don’t go through the effort of shopping around for new mortgages when it comes time for renewals. If they can capture a larger share of new home buyers now, they will have a bigger pool of mortgage holders when rates begin to rise. In general, barring a steep rise in rates and huge loan losses, banks make more profit during an uptick in rates. This is because the ‘spread’ between what they pay on deposits and what they make on loans widens.
So what does this have to do with you? They key is not to let the bank’s sales tools trap you in their bid to gain market share. Here are two strategies to avoid low mortgage rate traps:
- Don’t let the fact that rates are low encourage you to purchase more home than you should or do a bigger renovation than you planned. Your lender will try to tell you how much loan you can afford. Don’t accept their figures. Do you own calculations. Assume rates are going to go up in the next 5 years. Will you still be able to afford your mortgage payment if rates jump 1%, 2% or even 3%?
- If you do take on a new loan, or renew, at these ultra low rates make sure you gain by the monthly savings. If you renew don’t lower your monthly payment. If you were paying based on a 4% loan yesterday and could make the payments, keep your payments the same. Put ALL of the benefit of the reduced rate towards principal. Then when rates rise, you are further ahead.
Low interest rates can be good for the consumer. The trick is to be smarter than your lender.