Fixed or Variable? Which is best?
Discounted variable rate mortgages are very attractive. With Prime at 2.85% your FIVE YEAR variable rate mortgage could be about 2.20%. That’s a pretty great rate! Consider the average discounted fixed 5 year rate is 2.89%. That’s a .69% spread. On a mortgage of $350,000 amortized over 25 years with accelerated bi-weekly payments it’s a difference of $51.68 every 2 weeks.
So here are a few things to consider:
1) The Bank of Canada sets the Target Overnight Lending Rate which is what Canadian banks use to determine the Prime Rate. Generally, it is the pace of the economy (or lack of) and inflation which drives the Bank of Canada to stay, increase or decrease. So, when things are booming and inflation is rising, the BoC will raise the rate and decrease it when there are economic threats like dropping oil prices. Where do you think the economy is headed? Up, down or stay?
2) Variable rate mortgages are harder to qualify. Federal guidelines are that you must qualify at the Bank of Canada 5 yr POSTED rate which is now at 4.79%. This is great to protect you if the rate increases, however if your cash flow is tight or you need to maximize how much you can borrow then stick with the 5 year fixed rate. Its’ still a great option.
3) Changes in income? Is your income on an upward swing or downward? Will you be bringing in less money or more? The Bank of Canada typically increases the Target Overnight Rate at a quarter percent at each meeting so it tends to be gradual. No one really knows what will happen and in fact most of the economic projections last year didn’t see the current situation that caused the Bank of Canada to do a reduction. If there is an increase could you easily make the payment and how would it affect your other obligations? For example, with a 2.20% VRM increased by 1% on a $350,000 mortgage amortized over 25 years you will pay another $75.60 bi-weekly. Sure it’s more now but remember you saved interest costs before the increases.
4) Penalties. Life happens and sometimes you need to get out of your mortgage. The reasons are not important but what you need consider is the cost. Fixed rate mortgages prepayment penalties are almost always far higher than the variable rate mortgages. Typically a Variable Rate mortgage is 3 months interest while the fixed is based on the Interest Rate Differential. Note, all lenders have their own terms and conditions and ways they use to calculate the penalty so check with your Mortgage Broker first before you sign the dotted line.
5) Payment shock. If you want a variable rate mortgage and don’t want to be surprised when Prime increases in most cases, you can arrange to make a higher payment than the contract requirement. Think Prime will go up 1% in your term? You can have the payment set at that higher rate so there’s no shock and in the mean time you are paying down the principal.
6) Lock in. Most Variable Rate Mortgages allow you to change to a fixed rate mortgage at any time. Just remember you will get the rate that is available at the time – not what you could get today. Also, find out what kind of rate you can lock in to – will you get the best discounted for the remaining term or with the lender extend term with what they have to offer?
I recommend getting a comparison on what is available for you and discussing the whole situation with your mortgage broker. Make a qualified decision you can be comfortable with.