York University professor Moshe Milevsky says he never anticipated the credit markets of the last year.  The 2001 study that Milevsky did, examined the previous 50 years to determine whether consumers benefited from locking into a fixed-rate mortgage or going with a variable-rate product linked to prime.

 Consumers did better 88% of the time by going with the variable-rate option. The study has been used by banks to lure consumers into variable rate products. Currently, about 25% of mortgage holders have gone with floating rates.

"I've written seven books and 100 research articles and that's the one I'm known for," says Mr. Milevsky, with a laugh. "I just wish some of these banks would mention the author."

He says the study results still hold true. If you factor in the past nine years, the variable rate probably does better about 96% of the time.   But that doesn't mean if you are looking for a mortgage today you should float, he says. "There is another element of risk to analyze," says Mr. Milevsky.  He's refering to the volatility in the mortgage market for variable-rate products. The variable rate is still tied to prime, but the discounts and premiums being offered are moving up and down wildly.

A year ago, consumers were being offered discounts as much as 90 basis points below prime, meaning those people who took it are now borrowing at 1.35% based on the current prime rate of 2.25%. When credit markets tanked a year ago, variable products were being sold at 100 basis points above prime.  Credit markets have calmed since. Bank of Montreal announced a week ago that its variable rate was down to 2.25%, with no discount or premium.

The Bank of Canada may have pledged to not touch the rate until next June, but consumers getting into variable rate products are facing the risk that the discounts they negotiate today will look pretty ugly in a few months.  Worse yet, the variable products being sold by the banks are generally closed mortgages, so they cannot be paid off immediately without penalty.  An open mortgage can be paid off at any time, but you pay a higher rate for the privilege.

With such confusion in the marketplace, these days even Prof. Milevsky is leaning somewhat in favour of the five-year closed fixed-rate mortgage. On a discounted basis, some lenders are offering rates as low 3.69%.

"At some point, people have to ask themselves if they can afford the fact that eventually these things are going to go up, whether it's in one year, two years or five years," he says.

National Post - Garry Marr, Oct 5, 2009