It’s the age-old question. Do I go fixed? Or is variable rate the better option? There are many that believe that variable is the better choice. All the time, and for every person. But is this really true?
Everyone has different tastes, needs, goals, interests and ambitions. So if we are all so different, then why would we all make the same choice with our mortgage?
Whether to go fixed or variable really depends on the person. It is by no means a one size fits all option. When taking variable, you have to be comfortable with the fact that your rate and your payment could increase at any time.
What can we expect over the next five years?
There are eight scheduled rate announcements per year by the Bank of Canada. We have now seen five increases to prime rate since July 2017. Back in the fall, it was widely predicted that prime rate would increase at least two more times this year, perhaps even by the summer. However, with new economic uncertainty created by the announcement of the GM plant closing in Ontario, and the oil situation in Alberta, and the trade war between the US and China, the BOC may not increase rates as quickly as they were hoping too. Even if they were to move forward with their planned increases, we could then expect to see prime rate level off, or even start to drop back down again. It would be quite a rare situation for us to go the next five years without seeing any decreases and chances of that happening would be quite minimal. In fact, it would be unprecedented, and therefore extremely unlikely.
The above is all speculation and anything can happen. In the period between September 2010 and July 2017, one of the longest streaks in history without an increase to prime rate, every year leading economists were predicting that prime rate would increase ‘next year’. However, that never happened until 2017. In fact, it ended up decreasing. Twice. Anything can happen here.
Always consider the spread between fixed and variable
When making the choice between fixed or variable, it’s also important to look at the spread between the two options. Right now, the lowest 5 year fixed rate has come back down to as low as 3.29%*, with the lowest variable rate being as low as prime -1.20% (2.75%)*. A spread of 0.54%. Three rate increases and your variable rate would move above today’s 5 year fixed.
So this means you are losing out and that the fixed rate would have been the better choice, right? Not so fast.
Even if prime rate were to increase this year to the point where it goes up above the fixed rate you would be offered today, that doesn’t mean you would be losing. Not at all. You would just start to give back some of your savings. You wouldn’t know until the end of the five year period if you came out ahead. Again, it would be an unlikely scenario for us to go the next five years without seeing any decreases.
What happens if your variable rate moves higher than the original fixed rate offered?
Let’s say you have a $400,000 mortgage and your options are a 5 year fixed at 3.29% or a 5 year variable at 2.75%. A spread of 0.54%. Now let’s say prime rate were to increase once per year over the five year term, starting with one year after your mortgage closes. That would mean four increases over that period. By the end of the five year term, your variable rate would be 3.75%…. or 0.46% higher than the original fixed rate option.
In this situation, you still would have come out ahead by $1,432.76 had you have chosen the variable rate mortgage… despite the fact that your rate had risen almost one half percent higher than the original fixed rate option. That’s four increases over the next five years with zero decreases. As mentioned, it would be extremely unlikely to see no decreases to prime rate over that period.
Given the above situation, variable is definitely a great choice for many. Over the past 30 years, people have typically come out ahead with variable rate. This doesn’t mean they ALWAYS come out ahead with variable, however.
Is variable the right choice for you?
The question is, how would you feel if your rate and payment were to increase within the next few months? and then again a few months later? These are things that you have to be comfortable with when considering a variable rate. If you will feel anxiety at the thought, then a fixed rate might be a better option.
The best choice isn’t always the one that saves you the most amount of money, it’s the one that allows you to sleep soundly at night.
As far as which one is better? The better question is which one is better for YOU personally. If you have a higher tolerance for risk, then you may want to consider the variable rate. If you’re more risk-averse, then I would suggest going with the fixed option.
A solid variable rate strategy
One strategy I often suggest is to go variable, but set the payments to match that of the 5 year fixed option. After all, you were prepared to pay the higher payment anyway. The additional payment will go straight to your principal and will significantly accelerate the payoff of the mortgage. If you were to take the fixed rate, the difference in payment would be applied 100% towards interest.
You can also take it one step further and increase the payment a bit more each year. Also, this way when rates do increase, you’ll already be making a higher payment so you wouldn’t really notice the increase as you are already in ahead of it. You’re already making the higher payments and are now ahead of the game. You’re increasing your payments when YOU want to and not when you’re forced to. This way, YOU are the one in control, not the Bank of Canada. Note that your payment will still increase further when there is a rate increase, however, you can easily lower it back down to where it was before so your payment doesn’t need to change.
I talk about these strategies in detail, as well as others in my book Beat the Bank – How to Win The Mortgage Game in Canada
*The 5 year variable at prime -1.20% (2.75%) is available for high ratio (insured) mortgages only. The rate will be a bit higher for non-insured (conventional) mortgages. The 5 year fixed at 3.29% is available for both insured mortgages, as well as insurable mortgages with 35% or greater down payment/equity. There are low rates available for all qualified applicants. Reach out to me to get a quote based on your situation today!
Paul Meredith is the author of the Amazon #1 best selling book, Beat the Bank – How to Win The Mortgage Game in Canada, and has ranked as one of the top 75 mortgage brokers in Canada since 2016. He was a finalist for Mortgage Broker of the Year in 2018, and can be seen as the exclusive mortgage broker on season two of TV’s Top Million Dollar Agent.