Time to Get Your 10 year Mortgage?

Time to Get Your 10 year Mortgage ?

(First published by Rockenomics May 1, 2011 at PinnacleDigest.com)

Anyone reading financial articles already knows that there is significant economic trouble around the entire world. Earlier this week, Ben Bernanke reiterated the Fed policy of maintaining near zero interest rates and the Bank of Canada has also backed away from raising rates at least until the fall of this year. This of course means that both countries will continue to print money  - the Yanks to monetize the debt that no one else wants and the Canucks to prevent the Loonie from running too far ahead of the Greenback.

A recent article published by Agora Financial’s Bill Bonner recommended that people start spending their money like they stole it. When you fully understand the fundamentals around the US debt situation and the fallout that could ensue, his argument makes a whole lot of sense.

Mortgage interest rates have been hovering near historic lows for much of the past 7 years and pressure is mounting for governments to start fighting inflation. Inflation figures according to Bernanke are nominal and meet their ‘target’ of 2% annually. (Why any country is targeting a minimum inflation rate is beyond me – it makes no sense economically). His preference for the government’s core rate which excludes the volatile food and energy components makes him look like a soothsayer which of course is the result of the aim of all Keynesian economic theory – to create an image of the economy rather than tell what is happening in the economy.

According to John Williams of Shadowstats.com, the real rate of interest is near 10% based on the calculation method used up until the Reagan Presidency. If you don’t believe in John’s truth telling mission, perhaps you would believe Google’s Price Index instead? Google is developing its own basket of goods to judge the value of inflation. In Applied Economics Quarterly Vol. 55. No 2 (2009) , the entire methodology is laid bare and it will put the current measurement methods to shame in both accuracy and speed of delivery.  Since that measure has not published any data yet you could use the MIT measure that is available called the “Billion Prices Project” which has automated the process by using web-bots that troll the internet. Inflation is at 3.45% over the past year in the U.S, double the amount the Fed admits to, but 3.1% of that amount has come in just the past 4 months suggesting that inflation is spiking upwards.

Now to the title of this week’s blog: Time to Get Your 10 Year Mortgage.
There are a few lenders in Canada that offer 10 year fixed rate mortgages (and many more in the USA) with the lowest national published rate available being 4.84%. You can knock another 15 basis points off if you have a solid credit score and argue for it. Of course, the question is why you would want it when you can get an adjustable 1 year rate for just 2.1%.
Here’s the rationale and you certainly don’t have to agree with me. I can afford a fixed rate loan under 5% with the lowest possible payments pretty much forever. It eliminates the interest rate risk for a full 10 years and that is a lot of peace of mind. In the early 1980’s when Volcker raised rates to fight inflation, millions lost their homes because they couldn’t afford the interest payments and since I can see this coming, I don’t want to be in that boat. By taking on this 10 year fixed rate mortgage, I effectively shift the interest rate risk to the financial institution.

Here’s a scenario that may help to clarify (skip to last paragraph if it’s already clear)

Assuming we both borrow $500,000 (for simplification I am using interest only loans rather than a blended mortgage) – you choose the 1 year variable rates and I choose the 10 year fixed rate. The interest only portion of the 1 year loan is $2100/100K while the 10 year rate at 4.69% will cost me $4690/100K. That’s an additional $2590 out of pocket to go with the 10 year rate. WOW – doesn’t look good for me does it?

Let’s assume that the Bernanke miracle of zero interest rates continues for 2 more years and that Carney follows suit in Canada. Over that time I’ve spent $7770 more in interest than you. In year 4, interest rates climb by 2% to 4.1% so you now pay $4100 and I’m still paying $4690 and by year’s end I‘ve now paid $8360 more than you in interest.
Year 5 and rates continue to climb but at a faster pace as inflation is getting out of control. Bernanke raises rates to 6.5% (at this rate, the interest portion of the US debt is nearly equivalent to the total Federal tax revenue) and you still pay the 1.1% loan premium or 7.6% for a total of $7600 in interest. By year end I have paid $5450  more than you.
Year 6 is when it really gets interesting. Fearing the Us becoming a banana republic, Bernanke tries to emulate Paul Volcker and raises the US prime rate to 14.5% and you’re paying 15.1% or $15,100 interest. In year 7 the rate hikes continue upwards to 21.5% and you pay $22600 in interest unless of course you default on the loan. By the end of year 7 you have now paid $22870 more than me and there are still 3 years left on my fixed rate loan.
By the end of the 10th year, you have paid at least $50,000 in interest more than I did under this scenario. Of course, I didn’t tell you that I borrowed the money to invest in gold and silver, both of which grew exponentially over the life of this interest only loan and by the end of year ten I sold a small portion and paid off the principle.
I am putting this into action right now because a 5 year term rate would cost about 4.35% and the 10 year rate can be had for 4.84% or less via True North Mortgage. Historically these rates are extremely low and by the fall they will likely be heading higher. Within three years they could easily be 10% to 15% for a 10 year fixed, so the time to do this is before September. Most companies offering 10 year mortgages will only accept 1st mortgages so you will have to discharge your current mortgage and that could be costly. Be careful and weigh all your options but be cognizant of the debt time bomb that is going to drive inflation higher as the U.S. monetizes its debt.