Continuing on from my last post, here we get into the nitty gritty on what it really means to put your eggs in more than one basket….
One knock against hybrids is that they’re more expensive at renewal. They must be refinanced, which usually entails legal fees. By contrast, when you switch lenders with a standard (“non-collateral”) mortgage, the new lender usually pays your legal and appraisal costs.
This disadvantage is most applicable to folks with smaller loan sizes. If your mortgage is $200,000 or more, those refinance costs equate to a rate premium of less than a one-10th of a percentage point on a five-year mortgage. That’s peanuts for the diversification benefits of a hybrid rate, especially if you can find a lender or broker to cover those refinance costs.
Hybrids to avoid
There’s a strategy in bond trading called laddering. That’s where you buy multiple bonds with different maturity dates to lower your risk. If rates dive, your long-term bonds will still pay higher interest. If rates soar, your short-term bonds will mature quicker, letting you reinvest in better rates sooner.
Homeowners can ladder, too. One method is to get a combination mortgage and set up five segments: a one-, two-, three-, four- and five-year term. That way, only a portion of your borrowing will mature every year. So you’ll never have to renew the entire mortgage balance at unfavourable rates.
That may seem appealing on the surface, but it’s really a sucker’s play. The problem is, whenever any segment comes up for renewal, the lender has you over a barrel. Lenders aren’t charities. They maximize revenue at maturity by evaluating your available options. They know that people with staggered terms have to pay a penalty to leave if they don’t like the lender’s offer. Those penalties can cost thousands (or tens of thousands). So lenders typically give lacklustre renewal rates to borrowers with differing maturity dates.
Quick perspective: If you have to pay a rate that’s even two-10ths of a percentage point higher, that’s roughly $1,800 in extra interest over 60 months on a typical $200,000 mortgage.
The best combos
If you’re going to go hybrid, match up the terms. For example, pair a five-year fixed with a five-year variable. That way, both portions mature at the same time. Then, if you don’t like your lender’s renewal quote on one portion, you can fly the coop with no penalties.
And by all means, shop around. The majority of hybrids have junk rates. Look for rates that are within 0.15 percentage points of the market’s best, for each segment in the mortgage.
Should you get one?
Virtually no one on Earth can consistently time interest rates. No banker, no broker, no economist, no Bank of Canada governor, not even money managers paid millions. But with hybrids, timing matters less. They take the guesswork out of rate picking.
Granted, if you’re a well-qualified, risk-tolerant, financially secure borrower, you’re often better off in the lowest-cost standard mortgage you can find. And there’s historical research to back that up. But if your budget has less breathing room or rate fluctuations make you slightly queasy, hybrids are worth a look.
Just be sure that your mortgage is big enough, that all portions renew at the same time and that you avoid hybrids with uncompetitive rates on one or more portions.