I have a few friends with variable rate mortgages and lines of credit. “Demand products” that they were sold in good times. Since I’m the “economics whiz” of the group (which doesn’t say much about the group!) they’re asking my advice on offers their banks have given them to either turn their variable rate line of credit (house was the security), into a fixed rate mortgage (they had borrowed money at 1% (variable rate), to pay off a mortgage at 4.5% pretty smart huh? And now the bank is offering to turn the line of credit into a straight 5 year mortgage) - or to simply raise the rate of their existing 5 to 30 year mortgages, locking it at 5% vs. the prime + 2 points variable rate they’re getting currently. So my friends falsely assume my economic understanding means I possess knowledge about specialized financial markets, and unfortunately most experts I could direct them to are Keynesians/cool-aide drinkers, meaning their predictions and advice would be HIGHLY suspect. Which is why I’m here. I feel I have an obligation to seek out some advice from people who really understand what’s going on.
My understanding of the theory of interest rates is as follows: standard ABCT; low interest rates stimulate longer term unsustainable investment, and when the system busts, everyone finds out, all of a sudden, that there is maybe .1% of the savings in existence that the interest rate “indicated” previously - causing the supply of saved money to become quickly scarce. Lending stops, or is done so at a huge premium (30% etc.). Meaning being bound to variable rate anything leaves you open to sudden, exponential increases in your liabilities.
So, what I should be telling my friends is: LOCK THAT RATE FOR THE LOVE OF GOD!!! Because that variable rate means that the bank, when faced with new, mounting scarcity of saved money, will hike the interest rate of the mortgage accordingly (30%), and its better to get the bank contractually locked in to a seemingly high rate at the moment - which is actually a great rate after the hyper-inflation-apocalypse has happened. Basically, it’s a great idea to shelter oneself from market fluctuations.
Only problem is… even though the central bank lowering rates does not equal banks lending at lower rates (fed rate may be 0%, but the banks could stick to 30% just as easily), and as I understand Gary North to be saying: banks will only lend at perpetually low rates if they’re forced to. So, even with long-term central bank rate cuts, Volkneresque high rates may still occur, and it is FAR better to simply lock in at 6% (vs. 1% variable) no matter how much the principle is because high mortgage rates are almost inevitable? And even though the executive may force banks to loan their tarp money/future credit and make my friends “suckers” for locking in at a high rate, the stakes are too high to stay with variable rate demand products?
Pardon my errors, but can anyone tell me what’s going on? I’ve hit a wall with regard to my own understanding of mortgages (livelong renter) p.s, this is in Canada, if that changes anything.
I don’t mean to use an educational forum to solicit free investment advice. I personally have no stake in any of this, but I want to be sure my understanding is sound before I give my advice.