Mortgage Financing

M.A. Milevsky

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Mortgage Financing and Liability Allocation

M.A. Milevsky

June 2004

In late March 2001 I wrote a widely cited report entitled: Mortgage Financing: Floating

Your Way to Prosperity1 in which I argued that Canadian consumers were better-off

financing their mortgage at a floating or variable rate of interest compared to the

traditional choice of a 5-year fixed rate. With more than three years since that report,

and thousands of Canadians who have since taken variable rate mortgages, it seems

this was a good call.

But with the Bank of Canada poised to raise rates in the near future it is time to revisit

the ideas behind variable rate mortgages and how they can be applied to your client.

More importantly, I will take this opportunity to introduce the concept of liability

allocation which is the symmetric counter-part to asset allocation on your client’s

personal financial balance sheet.

First, some historical background. In March 2001, the quoted annual percentage rate on

a typical variable rate mortgage (VRM) was 6.5% – which was also the prime rate of

interest at the end of March 2001 -- the average 5-year fixed rate was 7.5% This

modest spread of 100 basis points represented an immediate monthly saving of $60 per

month on a $100,000 loan that was amortized over 20 years for those who selected the

floating route. And, while this number might not have seemed very meaningful at the

time, as variable rates dropped from 6.5% to the current neighborhood of 3.5 to 4.0%,

the difference compounded to quite a substantial sum.

1 The original report was funded by a research grant from Manulife Financial and is currently available on

the website of The IFID Centre at www.ifid.ca. The report was also summarized in a short article entitled

“Go with the float: Fixed rate mortgages offer piece of mind, but not much else” in the April 2001 issue of

the National Post Magazine (page 41).

M.A. Milevsky

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Exhibit #1 and #2...