The best way to determine the future is by looking at the past. Albeit, the past isn’t always correct, but history does tend to repeat itself.
A History of Prime Interest Rates
.svg "federal funds rate, prime rate graph")
By reviewing the above graph, it is easy to determine that we are at the lowest prime rate has ever been. It is also easy to see that prime rate has gone as high as 19% during the early 80′s.
Prime rates most volatile swing had been from 1978 to 1981 where prime rate had increased from 5% to 19%. This was an extremely dramatic increase, and many homeowners had lost there homes during this time frame.
Ever since the early 80′s prime rate has been trending downwards; however, interest rates cannot go lower than zero, so the only other direction is up.
Fortunately, the Canadian banking system has evolved from days of zero inflation, and we have created a more prudent banking system; however, it is still not impossible for rates to rise, even dramatically again.
Some key trends to recognize in the graph is that when the graph sharply increases or decreases, the rates must sharply do the inverse in the next few years to balance out, so if that theory remains true, then in the next few years, we should expect to see prime rate raise possibly as high as 4% to 5%.
Unfortunately, we cannot predict the future, so there is no way we can determine what will happen in the future; however, by looking at the graph, it is easy to determine that you need to protect yourself against an unexpected increase in prime rate.
Variable Interest Rates vs. Fixed Interest Rates
An effective rule remains even today among mortgage professionals, buy down your rate with a variable rate mortgage when interest rates are high, and lock in a fixed rate when interest rates are low.
This reasoning holds mostly true with effective market timing, in most cases market timing is too difficult for the average mortgage holder, and the mortgage holder will lock into a fixed rate too early or too late to take maximum advantage of the low interest rates. This results in a good amount of the time, the average borrower should remain with a variable rate; however, if you are interested in security, then this is incorrect.
The ability to sleep at night without worrying about the markets is an important luxury. By choosing a fixed rate it ensures that you are aware what your monthly mortgage payments, and when you will have your mortgage paid in full by. It removes a lot of the uncertainty of your mortgage payments increasing or having to pay your mortgage forever due to rising interest rates.
Your risk tolerance helps to determine what product is best for you; unfortunately, there is no simple calculation that will definitely tell you what works for you.
What Interest Rate for Today?
This is one time in history where the solution is pretty clear. Seeing as interest rates have no where else to go but up, then you should feel pretty secure when locking into a fixed rate; however, how long will we stay at these low rates? No one knows the answer to that.
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