It often depends on who you ask
Whether you are a nervous first time home buyer or a multiple property owning experienced buyer – the rate decision is always a hard one. The first thing you do when decisions are hard – ask for advice.
Let’s start with mom and dad. We bet they say lock in, go with the fixed rate. “Variable rates are risky” is a line often heard from our client’s fathers! Their decision making and instincts on this are based on recent history – the 1980’s were a time of notoriously fluctuating variable interest rates and many people were caught in a quickly increasing rate environment. This fairly brief moment in history pushed Canadians towards fixed rate choices far. But the research doesn’t back the decision. Some interesting Canadian studies prove that in many cases over long periods of time variable rate mortgage holders pay less in total interest costs.
Your friends – especially first time home buyers and young professionals have researched their rate choices and more and more are choosing variable rates. They understand the small risk in regards to payment increases and plan ahead accordingly – managing their budgets, building reserve funds, and increasing their payments before they need to. And if you are buying your third or fourth home your friends who have experienced the interest cost savings of variable rates will most likely give you advice to do the same!
Your mortgage broker will provide the options, interest rate choices, and the pros and cons of both. You can then work together to make an educated decision that works for your budget, lifestyle and future plans!
Fixed rate win in these three situations
The income levels on your mortgage application were just enough to get you approved by a lender. And you don’t expect your income to increase anytime soon. This means that the debt servicing ratio of income to mortgage and consumer debt was at the edge of the approval range. You simply need a set monthly payment with no variation over the term in order to budget.
You find finances stressful and are very nervous about taking on a variable rate. The truth is watching the Prime rate changes and announcements will stress you out! Take the fixed rate and sleep well at night – no worry!
The key factor in the fixed rate decision – your mortgage is with a lender that does NOT charge high penalty amounts to break the mortgage mid term. Then that fixed rate might be a great choice. But if a massive mortgage penalty is a concern beware of which lender holds your mortgage. The range in penalty amounts charged should you need to break your mortgage year three of a five year fixed term are incredibly wide ranging. For a $350,000 mortgage balance the range of penalty amount is from $1,500 up to $12,000 – how and why you ask? The penalty amount is based on the lender’s policies on breaking your mortgage early (the big five banks have policies that result in very high penalties) and almost all of Canada’s non-bank national mortgage lenders have policies that result in much lower penalties – often 1/5 of the bank lender amounts. There are at least eight factors involved in this calculation – we can talk you through it for each lender if needed!
Variable rates win in these three situations
Your variable rate is at least .75% to 1% lower than the best five year fixed rate offer. In this situation you can take advantage of much lower interest costs and lower monthly payment and if you really want to get ahead you can use those extra funds to pay down your mortgage principle each month. For example if the variable rate is 1% lower than the best five year fixed rate and the payment is $220 a month less take the variable rate option but setup an extra payment option to increase your monthly payment by $220… you were willing to pay the $220 extra per month to access the “security and safety” of a fixed rate – well do just that and put those funds to good use! You can afford the higher payments and the extra funds go directly to principle – paying down your mortgage faster.
The chance of life changes is very high – your employer may transfer you to a new city, you maybe quitting your job to become self employed, you aren’t sure about your marital status, you may be adding to your family (triplets happen more often than you think), or life in general is unpredictable… then a variable rate is great because the penalty to break it is very, very low compared to a fixed rate mortgage. It’s based on three months interest cost and often less than $1,000 depending on the size of the mortgage!
You know that your income will be increasing (think bonuses, over-time, salary raise), your debt will be decreasing, or you may be coming into an inheritance or some extra funds. In these cases you can withstand a possible payment increase. Your budget is in good order and only on the up swing!