March 3, 2010

You can't decide what to do with your mortgage? The good news is you don't have to.

Anyone negotiating a mortgage today is labouring over whether to lock in their rate. Yesterday, the Bank of Canada reiterated its pledge to keep its key lending rate at a record low until July, but has not committed to anything past the end of the second quarter.

And that has everybody guessing.

It's tempting to stay variable. The banks are back to discounting and variable rate products tied to the current prime rate of 2.25%, can be negotiated for as low as 1.95%. Meanwhile, if you do want to lock in the rate, you are guaranteed a rate as low as 3.75% for the next five years.

So, what to do? How about going long and short? York University professor Moshe Milevsky, author of Your Money Milestones, says in many cases, debt diversification does not make sense. For some, it means spreading out their liabilities across everything from mortgage to lines of credit, credit card debt to student loans.

"In many cases, debt diversification does not make sense because you are borrowing money at rates that are a lot higher," says Mr. Milevsky, who hypothesizes in the book that people like to compartmentalize their debt rather than consolidate.

But if you have consolidated all your debt in your mortgage, he says there is no reason why you can't diversify your loan across different terms.

"It's a bit of an insurance strategy against speculation," he says.

Think of yourself as a public company.

No public company would want all its debt coming due at the same time. And most public companies would keep a certain amount of debt subject to shortterm rates.

"With individuals, when it comes to mortgages, which is the biggest borrowing of their life, they go with the plain vanilla -- one duration, one maturity," says Mr. Milevsky, adding banks don't do a very good job of selling the concept of splitting up your mortgage. "They offer it, but they don't promote it." John Turner, director of mortgages with Bank of Montreal, says consumers with at least a 20% down payment can split up their debt at his financial institution with only one charge made against the house. It's then up to the consumer to slice up the mortgage in the way that works for them. "You can have shortterm variable, some long-term. You could also ladder your debt [so a certain percentage becomes due every year.]" Of course, there is a cost to this. On a regular mortgage, interest is calculated semi-annually. On the split-mortgage, which is run like a line of credit, interest is calculated monthly. The difference can add up to five basis points.

"The rates on the [split mortgage] are very competitive," says Mr. Turner.

On your statement, what you'll see will be all the terms consolidated into one monthly payment, making it just one loan you are receiving from the bank.

"We are trying to make it look as much like a mortgage as we can. We've done a lot of research on this and Canadians love this type of flexibility," says Mr.

Turner.

So far though, only about 6% of Canadian mortgages are of the split variety, according to the Canadian Association of Accredited Mortgage Professionals.

There are some downsides to the line of credit. For starters, it is loan that is callable on demand by your bank. Your mortgage is only callable when it comes due.

Mortgage broker Paula Roberts says another problem is a split mortgage can lock you into business with one bank.

"If you have a variable rate, a three-year term and a five-year term, your maturity dates are different," she says.

Say you don't like what the bank is offering on renewal of the three-year term, you can't switch financial institutions because you still have part of your mortgage with that bank.

"This is a strategy for the banks to keep your business," says Ms. Roberts.

"I think having options in your mortgages can be good, but too many options can make it difficult." So go ahead and diversify that debt, but make sure your bank offers some flexibility to negotiate rates when parts of the loan come due.

Garry Marr, National Post