Choices, choices: Is it time to lock in . . . or float?

Tom McFeat
CBC News
October 2, 2006

With most things we buy, the price isn’t much of a moving target. It can vary between one store and another, but once we’ve decided what to buy, the only big decision left is where.

For some products, however, the choice is not as easy. With mortgages and natural gas, for instance, the sellers have given us some additional options – to lock in at a certain rate for years ahead, or take one’s chances with the current rates and hope they don’t go up too much.

Make no mistake, these are agonizing choices. These are things with volatile price histories. Lock in for five years and you could watch helplessly (and enviously) while your neighbour who chose to float with the market reaps the benefits of falling rates. On the other hand, you could choose to stay variable and then hope that rates won’t skyrocket.

The difficulty in making this decision, of course, is that long-term price directions can be hard to predict. Who knows where interest rates or natural gas prices will be three years from now? Let’s look at the current situation and hear from some experts who say the market is already giving up some of the answers.

The mortgage dilemma

First, the numbers. A variable mortgage can be had for as little as 5.20 per cent these days, depending on the institution. On the surface, that looks a lot better than the posted five-year fixed mortgage rate at Canadian banks – now 6.60 per cent, as I write this. But typical discounting will take this down at least a full percentage point, depending on the institution and one’s personal credit score. So let’s say you can lock in for 5.6 per cent. The question is, should you?

Benjamin Tal, senior economist at CIBC, says his bank’s customers were shifting towards fixed mortgages earlier this year when interest rates were rising. Only 17 per cent have variable rate mortgages now, down from 22 per cent at the end of last year. But these days, Tal says people would be well advised to stay variable (and he has recently noticed a shift back to the variable camp). "The likelihood is that short-term rates are falling, not rising," he says. "Given where we are in the economy, jumping to a fixed mortgage may not be the optimal thing to do."

Tal, like many in the financial community, thinks the Bank of Canada will be in rate-cutting mode next year. That means the chartered banks will be dropping their prime rates (now six per cent) and variable mortgage rates will be heading down in lock-step.

He points out that people who go variable can always choose to lock in if they see rates starting to creep up. Choosing a fixed mortgage means you’re locked in for the whole term (which can be up to 10 years). Getting out early can be done, but only after paying a big interest penalty.

A few years ago, York University finance professor Moshe Milevsky looked at the 50-year period between 1950 and 2000 to figure out if people would have been better off locking in for five years or staying variable. He found out that the variable camp came out ahead of the fixed-rate camp 88.6 per cent of the time. "The main message is quite simple," he wrote. "Long-term stability has its price." The natural gas dilemma

Natural gas is another commodity that consumers can choose to lock in for one to five years (except in B.C., where deregulation hasn’t hit the residential market yet). Or they can choose to float and pay the utility’s going rate, which eventually moves up or down with the market.

Should people lock in to a fixed-rate natural gas contract from an energy marketer now that gas rates have fallen so much?

"No way," says Tom Adams, executive director of the consumer advocacy group Energy Probe. "The [fixed contract] prices that are out there from the marketing community have not caught up with market prices," he says.

Adams thinks utility prices have more room to fall. He’s generally not in favour of locking in. As far as natural gas is concerned, "the less insurance you buy, the better off you’ll be in the long run," he says.

But many residential and business customers think now is, in fact, a good time to lock in, according to, an independent natural gas broker.

"Earlier this year, from January to late August, people thought it was a bad time [to lock in], and they were right," says Energyshop vice president Ian MacLellan. "A five-year contract was near 40 cents [per cubic metre]. Now, prices are in the low 30-cent range and people think it might have hit the trough," he says.

"Natural gas prices hit four-year low," read a recent headline. But MacLellan says consumers should realize that those prices are for the "prompt month" – in other words, the price of gas for the next month. Five-year gas contracts, however, are based on the price of gas up to 2011. And those prices, even though they have declined, are not at a four-year low., which has a price comparison feature on its web site that allows consumers to shop around for the best deal from the marketers, says its records show that consumers in Ontario, for instance, would have been better off locking in to a long-term contract for 47 to 53 of the 60 months ending in May 2006.

Yes, says Energy Probe’s Tom Adams. But that was mainly a time when gas prices were rising. Now, they’re falling. Gas broker Ian MacLellan acknowledges that "if the market continues to fall, it’s definitely not better to lock in."

The question is: Will rates be lower a year from now, or three years from now? MacLellan says the trend line for gas prices shows an unmistakeable uptrend, admittedly with wild swings. For those consumers with little tolerance for risk, locking in does provide some peace of mind, he says.

There’s one point the lock-in and go-variable sides do agree on. "If you’re really concerned about natural gas prices, you’re far better to put money into attic conservation or weather-stripping," says consumer advocate Adams.

Gas broker MacLellan agrees. "You can save far more by conserving energy."

What if you can’t choose?

For those who can’t decide whether to lock in with a gas contract or stay variable in that mortgage, there is a third option.

Some gas marketers and mortgage lenders can arrange split-rate (or blended-rate) deals – part of your natural gas billings or mortgage will be on a fixed-rate contract for a certain period of time while the rest can stay floating – some downside benefit should rates decline and upside protection should rates rise.

Think of it as your own little hedge fund.

Tom McFeat Tom McFeat is the producer of the Business zone of CBC News Online. Tom joined CBC in 1979, and has worked as a TV reporter, writer/editor and producer at The National and at several regional CBC stations. Before joining CBC News Online, he produced The Money Show for CBC Newsworld. He is the co-author of two books dealing with online investing and money management.

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