One of the main questions we get asked, is – ‘What mortgage would you recommend? Fixed or Variable?’. It’s probably the biggest question in the world of mortgages and even more important now that we are in an increasing mortgage rate environment.
The only true and honest answer to give is that they are both the best mortgage to take – that is depending on your personality type and tolerance for risk.
One one hand, at the time of writing, the variable rate is still a good 0.50 – 1% lower than the available 5 year fixed rates. The variable may go up another 1% or possibly more – and then it is likely to come back down again within a 5 year term. So maybe a few thousands dollars can be saved with a variable rate – which is great!
But what’s the point in saving $3000 or $4000 if there is going to be constant worry over the next few years? Financial stress is proven to be some of the worst stress. What you can get with a fixed rate, which many consider to be priceless – is peace of mind.
Let’s take a few moments to go over the benefits and strategies that apply to fixed Vs variable Ontario mortgage rates. This is a good starting point from which we, your Ontario mortgage brokers, are happy to continue a personalized discussion with you.
5 Year Fixed Rate
If you’ve ever watched late night cable, especially if you grew up in the 90s, you probably saw the Ronco Grill infomercial where the tagline goes ‘set it and forget it!’. While this mortgage rate article is hardly a quirky infomercial, the fixed rate mortgage holds the same mentality. If you can get set up a nice low mortgage rate, you can’t lose – especially as mortgages continue to go up. You can make the payment, with consistency and predictability – and create a budget around your mortgage that you know will be reliable.
The fixed rate mortgage is great for a first time buyer, who may not be used to making large mortgage payments, along with the other costs and pop up expenses that come with home ownership. The fixed rate is also great for those who would consider them to be low-risk takers. For example, if they were to buy a stock or mutual fund, they would buy a low to medium risk fund with more predictable returns.
The peace of mind that comes with a good, low rate fixed mortgage is never a bad thing – and there is always that possibility that you could come ahead of a variable over the next 5 years. There is no guarantee as to what markets will do, but by locking in you control your risk.
5 Year Variable Rate
The variable rate mortgage has a proven track record of beating 5 year fixed rate mortgages, with an overall lower rate. This is what any advanced mortgage researcher will discover. However, there are several times where it would have made sense to lock in to a fixed. For example, just over a year ago – it would have been easy to lock into a fixed rate of 2.49% guaranteed not to go up for 5 years. I think anyone looking back at such a deal now, would have decided to go that route. Perhaps in a year from now, we could look back and say that 3.29% would have been an excellent rate to lock into. Does it sound like we’re a little biased towards fixed? Let’s take a closer look…
Our best variable rate is currently at 2.65% and our best 5 year fixed rate is currently at 3.29%. This represents a spread of 0.64%. In other words, if the Bank of Canada increases rates 3 more times, by 0.25, or .75% – then the variable rate just slightly moves ahead of what your fixed rate would have been.
Now, the big question is – how long will it take rates to move up by .75%? In all likelihood – this would take more than a year. With a rate increase on average every 6 months (as has been for the past year and a half) – it would take a year and a half for the rate to reach this point. So what if you spent the next year and a half making prepayments towards your mortgage, to pay it down faster? This would mean that you are getting ahead by thousands of dollars – so that when the variable rate does catch up to the fixed rate – you are already much further ahead on your variable because you took advantage of the lower rate. This is the big secret of variable – to make additional prepayments.
This strategy mitigates your risk, and sets you up for higher future rates.
Now let’s say, rates continue to increase for another year – by .25% every 6 months. While, you’re still not behind, because you just spent a year and a half making the prepayments to get ahead. While the exact timing may not hold true, its the strategy that was considering.
Now at some point – whether it’s after a .75% increase or a 1.5% increase – rates will start to come back down, as the Bank of Canada will want to stimulate the economy in an economic down cycle. So while rates are likely to keep going up, they are also very likely at some point in the next 2-3 years to start coming back down.
The effect one .25% rate increase has the same effect of a 0.50 – 0.75% in the 80 and 90s, because debt levels were much lower then. With debts at triple the level in society today, the effect of a .25% rate increase can have up to 3 times the effect on some households. Given this, a central bank rate of 4.5% today may have the same effect on our economy as a 9% Central Bank rate in the 1980s. Again, while these are generalizable numbers, the idea is that the economy cant withstand high rates like it once did – therefore the likely hood of higher than 4%-5% rates is very, very low.
This all adds up to a variable rate strategy, where the mortgage holder would ‘ride the rollercoaster’ up- and then right on back down when the economy takes a dip. The result could be thousands in mortgage rate savings.
The best type of customer for a variable rate, then, is someone who is able to comfortably handle this kind of risk – where rates head up for a while and then back down. This customer should be able to budget in for the higher mortgage payments- and even budget for an emergency situation where rates do go higher than expected for longer. We are only talking in likelihoods here, nothing is guaranteed. Therefore the income and the budget of the variable rate holder should be well prepared. Perhaps a smaller mortgage relative to income, or a mortgage towards the end of the amortization would be a good candidate for the variable rate.
But as mentioned at the beginning of this article, there is no wrong answer. As long as the individuals involved in the mortgage seriously consider their own experience with handling risk, and know well their skill at preparing for higher expenses – then there really is no wrong answer. Its not a fixed rate vs. variable rate question – it’s a what rate is best for you question all the way.