Can a variable rate save you money?

At True North Mortgage we spend our days watching mortgage interest rates going up and down at various Canadian lenders. We have noticed over the last few months that 5 year fixed rates have been trending downward. This is no surprise as it was predicted by such leading banks as TD, RBC and CIBC. In fact, most major lenders have issued statements suggesting that the 5 year fixed rates will be trending lower all year and may dip below 5% by the end of the year depending on how rough the recession is in the US. (rougher means lower 5 year rates)

The Canadian government has already responded to the weakness in the US by lowering the prime rate. In fact, on Tuesday, the Government of Canada will likely lower prime rates by another 0.5%. This will essentially make the True North Mortgage Variable rate product 4.00%, (P-75%) a product supported by ING Direct.

One of our clients called us recently to see if it would be prudent to break his fixed rate mortgage and take a variable rate mortgage, and perhaps lock in at some future date when 5 year fixed rates are lower. Quite frankly, after running the numbers we were surprised by the results.

Normally, we discourage this sort of behavior as the penalty can be quite stiff and there is little certainty that 5 year fixed rates will be lower in the future.

In his case, his current mortgage balance was $265,000 and he was locked into a fixed rate of 5.74%. He was curious how our variable rate would effect his payments. Currently, he is paying $1,655 per month and has been for about 1 year. At the variable rate his payment would be $1,394. That is a savings of $261/ month on his mortgage payments. Actually, the saving would be even greater than that because, due to the magic of amortizations schedules, the amount applied to principle would be $114 more every month on the variable.

As a result, the client would be better off by $375 per month. Of course, the client would have to pay a penalty of $3803 but that would only take 10 months to cover off.

In fact, paying the prepayment penalty would have a 120% rate of return; an obvious ?go? decision. The only down side would be if the client choose to lock-in his rate within the next 10 month period at a higher 5 year rate than he is paying currently. But that is really unlikely with all indictors pointing to the downward trend in 5 year fixed rates.
In any event, if you are currently in a 5 year fixed rate at more than 5.50%, please give us a call and we can work out your options.