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Risk & Reality-Combination Mortgages

General Angela Calla 28 Jun

Helen Morris, National Post · Saturday, Jun. 26, 2010

There is a lot to consider when deciding whether to go for a fixed or variable rate mortgage — not least, your tolerance of risk and your ability to sleep at night. Generally, fixed rate mortgages charge a higher rate and cost more, but payments are fixed for the term of the mortgage so you know what amount is coming off your principal. Variable rate deals, on the other hand, have generally cost less over the term of a mortgage but payments rise — and fall — with rate changes, so while your payment stays the same, the amount that goes toward the principle could vary.

In recent years, a number of lenders have begun offering mortgages that feature a fixed and variable combination.

“You would have multiple mortgage segments attached to the same home,” says Marcia Moffat, head, Home Equity Financing, RBC Royal Bank. You could set up a mortgage where, for example, you have “half your mortgage as a five-year fixed rate, a quarter of your mortgage as a two-year fixed rate, and you could take a variable rate mortgage for the other part.”

A number of brokers have seen increased interest in these umbrella products.

“Combination or hybrid mortgages are growing in demand,” says Rosa Bovino, a mortgage broker with Invis, “… mostly because people are unsure where the market is going. For those who are not comfortable locking in the full amount and want to play with the prime rate, there are some great variable rates out there where you’re … paying 1.9%, which is phenomenal.”

As well as being exposed to different interest rates, the amortization period for each segment can also be different.

“If you think of the other side of your balance sheet, with your investments, you would typicallydiversify– you wouldn’t take a single approach to all your assets,” says Ms. Moffat. “This is applying the same mindset to the credit side of the balance sheet.”

The hybrid mortgage has one other hidden asset, Ms. Bovino says. It can help households in which the mortgage holders have different risk tolerances.

“You do get couples, one is more conservative [and] the other one wants to gamble,” says Ms. Bovino. “That’s where you see a larger percentage of the clients taking on [hybrid mortgages].”

As with all mortgages, it pays to ask questions and read the fine print.

“There are a lot of nuances with those mortgages, and you have to be very careful with the lender you choose and the different … options and terms,” says Kim Gibbons, a broker with Mortgage Intelligence in Toronto. “I disclose up front what the risks are for those mortgages and when I do…for the most part, (clients) usually choose to go either fixed or variable. I am able to provide them with a better rate on either fixed or variable as opposed to the hybrid.”

Whether or not you pay a rate premium for a hybrid mortgage may depend on how it is structured.

“If they’re working with a mortgage broker, they’re going to get the wholesale rate so there is no upping any interest rate because you’re splitting your mortgage,” says Ms. Bovino. “Overall, by doing the combination mortgage you will probably pay less over the life of a mortgage … if a component of it is at the lower variable rate.”

Advisors also suggest thinking ahead to renewal time.

“When the mortgage comes up for renewal, there may be two portions of it that are up for renewal at different times,” says Ms. Gibbons. “This makes it very difficult to break the mortgage … you would have to pay penalties on the part that is not matured.”

While you cannot readily switch lenders mid-way through a hybrid mortgage, “the nice thing about them coming up at different times is that you’re not 100% exposed to any one particular rate environment. This is a way to hedge your bets,” says Ms. Moffat. “With a five-year and a two-year, you’ll be exposed to whatever the environment is in two years and the other in five years. It’s a bit of a laddering approach.”