Which is better variable or fixed rate?

Today I am going to write about the reasons to choose a variable rate mortgage and the reasons to choose a fixed rate mortgage.

But, first lets discuss the differences

Approximately 60% of our clients choose a 5 year fixed rate mortgage. It is the rate your parents and your parent’s parents chose for decades. It essentially guarantees that your mortgage payments will not change at all for the next 5 years. It is the term the bank likes to compete on and thus often provides the best value.

How do Banks set their 5 year rates?

Canadian banks set their 5 year rates by looking at their own borrowing cost. Fortunately their borrowing costs are very easy to determine. One only needs to go as far as the Bank of Canada’s website to see how 5 year bonds yields are fluctuating. Yields are up bank’s cost are up. Yields are down and so our banks costs. Bonds trade daily which means 5 year mortgage rates can move at anytime.

If you take a 5 year fixed rate mortgage the bank is taking on all that daily fluctuation risk for you.

A growing number of our clients are taking a variable rate mortgage. Variable rates are riskier but are very low. Variable rate mortgages are always describe as a discount off of prime. For example, a rate of prime minus .5% is typical. The bank of Canada sets Prime, and they adjust Prime up when the economy is getting better and they adjust it down when the economy is getting worse.

If you choose a variable rate mortgage your payments will rise as prime goes up and will go down as prime goes down. Sounds risky- it is.

But, the typical difference between a variable rate and a 5 year fixed rate is 2 to 3 percent. That is quite a bit and maybe enough to offset the added risk.

A CIBC study done a few years ago showed that 88% of the time it is financially better to take a variable rate mortgage over a fixed rate mortgage.

In my mind, before taking a variable rate mortgage, you must answer 2 important questions.

Can you sleep calmly at night, knowing the risks involved with a variable rate?

Can your budget handle a 3 to 4 percentage increase in your mortgage rate if prime climbs dramatically?

If you can answer yes to both these questions you should be happy with a variable rate mortgage.

You should also consider a variable rate if you plan on selling the property within three years or wish to pay down the mortgage quickly.

Good luck and happy house hunting.

Dan Eisner