I’m used to variable rate mortgages, but in the US I understand the situation is different.
If you take out a mortgage when the interest is low, you can keep it forever at that low interest. This is true even if the interest rate in the market increases.
However, when you take out a mortgage with a high interest rate and the interest in the market decreases, you can just refinance at the lower rate.
This sounds like a bad deal for the banks. How do banks deal with this asymmetry?
There are usually costs associated with refinancing. And after a certain time you need to have the house re-appraised. So the lower rate has to make up for the extra costs. I think the banks want to keep you as a customer rather then having you go on the market and select a new bank. But it is usually I good deal, I agree.
I have re-financed several times and each time I was able to shorten the loan term, pull out some cash and still have a lower monthly payment.
It would be a bad deal for the current noteholder institution to allow the debtor to renegotiate the rate whenever it’s advantageous to them, but it’s still better than losing the mortgage to another institution altogether. It’s not like your current mortaging bank can hold you captive at your current rate.
“I’ll take my business someplace else” is a strong negotiation point.
This! We refinanced twice in two years (stupid I know but it made sense for us) and had to pay $8000 total plus interest (fees rolled into the loan)
It’s baked into the rates they offer. The easiest way to see the effect is to compare rates of 10-year, 20-year, and 30-year mortgages. Typically, the longer the term, the higher the rate, and that higher rate covers the risk to the bank that the mortgage will be paid off before the term ends.
(Sometimes the yield curve gets “inverted” and the short term loans have a higher rate than the long term. This is because of market expectations and more complicated than I want to try to explain.)
They go bankrupt? As I understand, Silicon Valley Bank had too much of its assets tied up in lower-rate loans and such assets. When the inerest rates jumped significantly and fast, they could not adjust fast enough.
Seriously, though, this is why the spread between the prime rate and what you can borrow at and what your deposits pay interest at. If that changes a ridiculous amount, the banks are in trouble. It also explains why variable rates, which adjust with the central bank rate, are lower than fixed - less risk. The central bank also requires local banks to keep a certain amount of money on hand liquid to ensure market “wobbles” don’t cause the bank to have a cash flow problem.
(Aside - generally, rates don’t change fast and furious, are pretty stable. The last year may be an instructional time for financiers. It’s also why we are in this predicament. After 2008, once the economy was stable, central bank rates should have gone back up to a reasonable number -say, 2% or 3%? But it seems it was never a good time to raise rates… so now it’s a shock when we do. Also, virtually zero rates distorts the market, driving investors to find anything else that pays better - driving up those subprime mortage bonds, the stock market, real estate, whatever pays better than zero percent.)
In Canada, most mortgages are term - you sign up for, say, a 20-year mortgage but have a term - say, 5 years. When it’s up, you have to renegotiate a new term. So banks are rarely worried about anything longer term than 5 years. I was told the opposite applies in the USA - your mortgage, unless you refinance, is fixed for the life of the mortgage.
In many cases, especially mortgages, loans are such that paying off early incurrs a penalty to make up for the disruption and loss of future interest. For a mortgage, if the interest rate difference is not too large, the bank may forego that penalty to keep you as a customer. Plus, as mentioned, there are additional expenses that may be applicable in a refinance.
I bought my first house with a variable rate interest. I found out soon after that if interest rates go up, my interest rate goes up. If rates go down, my interest rate stays the same. When I bought the house my interest rate was 6%. 4 years later it was at 12.5% and my house payment had doubled. I couldn’t refi either because the value of the house never really went up. I sold the house 6 years after buying it for the same price I paid for it and I still owed the over $30,000. Between this and my now ex wife’s habit of running up huge credit card debts, I ended up filing for bankruptcy. Found out during the bankruptcy that I was a victim of a mortgage scam, the guy that got me the loan pocketed my down payment and got a loan for the entire purchase price. He ended up in jail but no one ever got any money back from him.
It’s not like the lender is making nothing when you refinance. The payments are set up that at first you’re paying more interest than principal (and the higher the rate the bigger the ratio).
Also, to be clear, variable rate mortgages (normally called adjustable rate mortgages) do exist in the US. They become more popular as rates rise, since the starting rate is generally lower than an equivalent fixed rate mortgage.
A lot of people in Canada deal directly with the bank, so this is less of a risk. After all, usually all this guy is doing is what you could do - shop around and find the lowest rate offered by a larger financial institution? Except, he found anothe way to get rich as well. Might have worked too, but Shirley you noticed your payment was too high?
From the bank’s point of view, a mortgage is similar to a callable bond, and valuation of those is fairly vanilla. To the bank a refinance looks just like an early repayment – the fact that another mortgage is being taken out is somebody else’s department.
I’d think with the recent rise in interest rates, that aspect of mortgage bonds is less important. Banks (or whoever the banks sold to) are holding on to mortgages giving returns at lower-than-prevailing interest rate (which is bad), but at least repayment risk is low.
Between purchases & refis, I’ve had at least a dozen different mortgages in the USA, both fixed & variable, and a few home equity loans too. I’ve never had a mortgage or loan with a penalty for paying off early.
There are laws in place restricting prepayment penalties. It can only be added to certain types of mortgages and only if you pay it off within the first three years. I would say they’re pretty rare nowadays.
The system in the US can also be confusing because there can be a different company that sells you the mortgage, accepts your payments, and actually lends the money. So the bank that you make payments to might just be a mortgage servicer, and they don’t care what your rate is, they make money by accepting payment, not from the interest on the loan.
So you might get your mortgage from Bob’s Mortgage and Bait Shop, who then immediately sells it. You then make your payments to Citibank, while the loan actually exists in a bond created by Fannie Mae.
They can buy an amortizing fixed-for-floating swap, or lay off the risk on the agencies. Corporates issue callable bonds all day long.
I would argue that banks are much, much better equipped to deal with this sort of interest rate risks than individual borrowers are and the UK monthly floaters and Canadian 5 year balloons seem like madness to me for individuals.
It’s the relationship between loan interest and deposit interest. When mortgage rates go down, banks take in less from interest on loans, but they also pay less interest on deposits. Moreover, when mortgage rates are lower, depositors tend to withdraw money for down payments on houses, so that’s another reason deposit interest payments are lower.
What happened to SVB was a little different than that. Their assets were tied up in low interest rate bonds. The problem came when they had to sell those bonds. They had to sell them for less than what they had paid for them. And their customers were not families but businesses and venture capitalists, mainly in the electronic industry. When the economy slowed down and electronic business were laying off employees and sales decreased they needed to withdraw money from their SVB accounts. There were enough withdrawals that SVB had to start selling off their bonds at a loss. And over time they had to sell off all of their bonds and could not cover anymore withdrawals.
I took out a fixed-rate mortgage in the 1980s at (around) 4%. It was “fixed” for twenty years which took us all the way through “Black Monday” (1987) & “Black Wednesday” in 1992), when interest rates rose as high as 15%.
I was made redundant for the first time in the 90s and naturally took a hard look at expenditure. We had a car loan on my wife’s car at the time, and I was shocked to find that paying it off early would have been more costly than letting it run its course. I put the cash into a high-interest savings account and continued with the monthly payment from that.
I had a variable-rate mortgage (prime rate minus a half, where prime is based on Bank of Canada rate but a few percent higher) so i was effectively paying in the 3% neighbourhood for 10 years. In 2019 I had the opportunity to fix at 2.74% for 5 years, not much different than the variable rate.
So next year I will have to renew with current interest rate, but by then expect the amount owing to be substantially less.
Canadian mortgages have a few restrictions - IIRC, there are “open” and “closed”. Open can be paid off without penalty but the rate will be slightly higher. With my “closed” I can pay off 10% of the starting principal each anniversary date, and I can alter my payments up to double (both of which I’ve done) with no penalty. There is a penalty for paying the whole off early - most banks will waive that if you are renewing, and many banks will pay the penalty for you if you switch to them.
The key here is that Canadian mortgage interest on primary dwelling is not tax-deductible, and there is no capital gains on primary residence sale. The obvious incentive is that Canadians tend to pay off their house rather than remortgage for cash flow, it becomes part of their retirement savings. There is also the CMHC which effectively is the only mortgage insurer in the country. A bank won’t loan to you if the mortgage can’t be insured (i.e. they don’t lose if you default - banking in Canada is a license to print money). CMHC establishes to guidelines over what is an acceptable balance of mortgage, down payment, and income. Canada barely suffered in the 2008 mortgage debacle.
I supppose another key point is that since about the longest mortgages seem to be 7 years (sometimes 10 years?) and typically no more than 5 years before refinancing, banks are at less risk of carrying longer-term underperfoming loans. People who think the current rates are a temporary spike can sign up for shorter terms and see.
Here in Norway 20-30 year mortgages are common. You also get a 27% tax deduction on interest payment.
Almost everyone here has a variable interest rate loan. You can get a fixed rate for a maximum of 10 years I think, but you cannot pay it off early without paying a penalty. The fixed rate is usually higher than the variable rate, so in most cases the variable rate will end up cheaper. A fixed rate is seen as a sort if insurance against higher rates.
In the last two years my rate has gone from 1.2% to 4.2%, and it’s continuing upwards.