One of the biggest decisions when choosing a mortgage is whether to take a fixed or variable interest rate. While there is much debate among mortgage holders between on which is the better strategy, the best person to make the decision is an educated customer, him or herself.
Fixed Rate Mortgage:
The word ‘fixed’ refers to the idea that the interest rate does not change for the entire mortgage term. Typically a mortgage term is of 5 years, but can be more or less depending on goals and strategy.
Pros:
- The main benefit of fixed term is its security or safety feature. The borrower knows that the payment is the same throughout the entire term of the mortgage and can budget accordingly. If interest rates increase, fixed interest and payments remains the same for the remainder of the fixed term.
- With inflation and economic development, your home value and income should rise, but your mortgage payment will remain the same.
Cons:
- The potential lack of interest savings, that could have otherwise been used to pay down the mortgage faster. The word ‘potential’ is emphasized because a variable rate mortgage could end up costing more than fixed if rates increase.
Variable Rate Mortgage:
The interest rate on variable mortgages fluctuates according to the prime rate as set by the Bank of Canada. For example, at the time of writing the Bank Prime is at 2.70%, and the discount that mortgage lenders are offering off of this bank prime rate is as much as – 0.65% – meaning the customer rate is 2.05%. It is this ‘prime minus’ number that a mortgage broker will typically negotiate downward on behalf of clients.
Pros:
- Potential Savings: Over the last 70 years, studies on mortgages have shown that variable rate mortgages have been less expensive, with lower overall interest rates than fixed rate mortgages.
- Ability to switch to a fixed rate: Many variable rate mortgages have the option of switching to a fixed rate without penalty. This provides comfort if rates begin to rise. A major point on ‘locking into a fixed rate’ relates to the kind of deal that a client would receive on the lock in. While many banks will lock their clients into high, posted rates, other lenders can lock their clients into highly discounted broker wholesale rates. This is a point worth noting if considering a variable rate that could potentially save you thousands of dollars.
Cons:
- While borrowers can save on interest rates by going variable, rates could increase quickly and catch the borrower off guard. A close watch should be kept on interest rates to decide when to lock into a fixed term. Altrua provides this service to clients.
With this information in mind, the following profiles may help clarify which product is right for you.
Variable mortgages are generally suited for people who are:
- Higher risk takers: Would invest in more risky Mutual Funds or stocks with a higher potential for both loss and return.
- Debt free or have little outside consumer debt.
- Are able to afford an increase in their monthly payment should the Bank Prime Rate increase.
- Are typically budget disciplined.
- Income stability is strong.
Fixed rate mortgages are better suited for those who are:
- Lower risk takers: Would purchase safer investments to sleep better at night.
- Have medium to higher debt loads, and who have more substantial monthly payment obligations relative to income.
- Not able to comfortably afford increases to their mortgage payments should the Prime Rate go up.
- Income stability is more variable
Given this, we can see that deciding whether to go fixed or variable can be a tricky decision, but with some consideration and a look at your life situation and goals, securing the right type of mortgage can prove to be a very rewarding experience.