Fixed versus Variable
One of the questions I am most often asked is “should I take a fixed or a variable rate”?
My answer to this question is different for each client.
My answer to this question may change based on the interest rate environment.
The last few years have been sobering to say the least. We were riding the high of historically low fixed interest rates and beginning to see them as the norm.
Where interest rates are sitting now (mid four to five per cent) is closer to the average interest rate Canadians have paid over the last twenty years.
This week I attended a learning event and the economist that presented to the group spoke the words we have all been waiting to hear. He did qualify his thoughts with the comment that no one has a crystal ball and we’ve all seen what can happen with Bank of Canada monetary policy.
What he did say is that he feels we will see prime rate drop 1.25 to 1.5 per cent over the next year.
What does that mean in dollars and cents?
As an example, if your mortgage is $500,000 and your variable rate mortgage is priced at prime less 1.05 per cent, if prime drops one per cent this means your payment will be $283.28 per month lower.
This math applies if your variable rate mortgage has a payment that changes every month. If your variable mortgage has a static payment (payment that does not change to follow changes in prime) your payment stays the same but more money goes towards the principal instead of interest.
So it seems like variable is the obvious choice if you are finalizing your mortgage right now.
But it may not be.
Circling back to where I said each client has a unique set of circumstances, variable may not be the best option.
Fixed rates for insured mortgages are hovering around 4.59 per cent (some lenders lower, some higher). For clients that are pushing to qualify for the maximum purchase price they can the one per cent difference between fixed and variable rates absolutely affects their borrowing power.
Lets say we are working with a family earning $120,000 annually. When we calculate their maximum purchase price using the minimum down payment and assuming $3,000 a year for property taxes here is the difference:
- Using a fixed rate of 4.59 per cent we are looking at a purchase price of $525,000
- Using a variable rate of prime less .95 per cent (5.49 per cent) we are looking at $475,000
Another consideration before choosing fixed or variable is individual risk tolerance. Do you have room in your budget if rates trend up instead of down that you will not be stressing if prime does increase?
Exit strategy is yet another thing to consider. With variable mortgages the maximum penalty you will pay if you pay your mortgage in full early is three months’ interest whereas with a fixed rate mortgage you will pay the greater of three months’ interest or your lender’s interest rate differential calculation. There can be quite a spread between the two.
If you are planning to pay off your mortgage in the next few years variable may be the route to go strictly for that reason.
And if you opt to choose a variable rate mortgage then decide you are not comfortable with potential changes, or if a few years in the fixed rates are far more attractive you can convert from a variable to a fixed rate mortgage. Win-win.
Deciding whether to go fixed or variable is absolutely an individual decision for all of the reasons above.
When the economist was asked whether he would choose a fixed or a variable mortgage himself right now there was no hesitation whatsoever.
“Variable all day long” was his answer.
It will be interesting to see where rates are a year from now.
