Home-ownership has been a stressful lifestyle lately. Between shaky home prices and volatility in financial markets, it’s hard to predict where it is that mortgage rates are going to be 6 months from now, let alone by the time our existing contract comes up for renewal. Combined with the way in which personal bankers tend to be just as clueless about the direction in which rates are moving as we are, we need to be able to take an objective look at how the domestic debt markets are developing so as to build up a strategy for handling our own personal mortgage debt responsibly.
The framework that a home-owner can use to evaluate movements in mortgage costs follows a simple ‘if-than’ structure. Since mortgage prices will simply be the result of government-mandated rates combined with a discount that the bank itself is willing to put on its sales, we can just look at how it is that the bank would need to react to changing government policies in order to maintain their business. We start with the simplest scenario of “what happens if the government doesn’t change anything?”
This is a pretty easy situation to evaluate because it means that the banks will simply follow the same rates as they have before. Just look at what the last promotional rate the bank offered was and assume that the next one will be very similar, if not exactly the same (you’d be amazed how often banks reuse promotional rates from the past just so that they can save on marketing expenses).
After looking at the baseline situation, we can start to branch out into examining what happens as rates increase or decrease. For when rates decrease, we can almost always assume that the banks will decrease their mortgage rates by a proportionate amount. However, if rates decrease by a large amount, the amount of discount that banks will apply to their mortgage rates (ie. prime – x%) will decrease as well, meaning that larger discounts from the government will create incrementally smaller benefits to borrowers. This same trend goes for rate hikes though, as banks cannot afford to lose all of their mortgage clients in the event of a massive rate hike. As such, larger rate increases from the government will be met by larger discounts from the banks.
So what does this all mean for a mortgage borrower? It means that mortgage rates tend to move slowly, but persistently, as a result of the discount buffer that banks will apply to their rates. Even though there are still periods in which rates will rise or fall dramatically, these spikes and crashes are still the result of a greater trend that can be evened out over time. Combined with the way in which banks often allow customers to average out their rate over time through a ‘blended renewal’ program, we can smooth out our exposure to interest rate changes to the point at which we are reasonably protected against uncertainty over time.