Fixed vs. Variable Mortgages

Are you a fixed or a variable person? If you’re a homeowner, it’s probably a question you’ve asked yourself once or twice. Buying a home can be a terrifying proposition, but landing yourself that perfect “dream house” does not mean that the difficult decisions are at an end. Every time you negotiate (or re-negotiate) your mortgage, the question (re-)rears its ugly head: Should you choose a fixed or variable mortgage rate? First, let’s clarify what each term means. Fixed mortgage rate Your mortgage rate and payments stay constant over your mortgage term. So, if you lock in at 5.44 per cent, this will be your mortgage rate for whatever term you’ve agreed upon with your lender. If you’re paying $1,200 per month, for example, that’s exactly what you’ll be paying until the end of your term. In fixed mortgages, interest is compounded on a semi-annual basis. Variable mortgage rate Your mortgage rate will fluctuate over your mortgage term. Your interest rate will change with the “prime” lending rate, as set by the Bank of Canada. For example, your rate could be Prime – [minus] 0.15 per cent. Payments in variable mortgage rates can fluctuate as rates go up for down — or they can remain constant, in which case the fluctuating rate will determine how much of your payment goes to principal and how much goes to the interest. In a variable mortgage, interest is compounded monthly. The central “pro” of the fixed mortgage rate is obvious: stability. You know how much you are paying per month, and don’t have to worry about flip-flopping figures. The con? You are locked in, so if rates go down drastically, you won’t be able to take advantage of it. This can cost you money in the long run. The central “pro” of the variable mortgage rate is that, in the long term, you will end up spending less on your home. Need proof? You’ll find it in the landmark research of Dr. Moshe Milevsky of Toronto’s York University, who proved with statistical evidence in 2001 that borrowers with variable-rate mortgages save money 88.6 per cent of the time. In 2008, Dr. Milevsky presented further compelling evidence: Based on data from 1950 to 2007, variable rate borrowers could expect to save money a whopping 90.1 per cent of the time. He also found that the average savings was $20,630 over 15 years per $100,000 borrowed. The above may make it sound like choosing a variable-rate mortgage is a no-brainer. Ah, ah, ah — not so fast! The con, of course, is that changes in interest rates could significantly affect your payments. If rates go up at a time that’s inopportune for your bank account, you could be left wishing you’d locked in while you had the chance. The historical economic statistics notwithstanding, lately some experts have been pushing consumers towards a fixed-rate mortgage. For example, a March 2012 report by BMO Capital Markets called “Time to Say Good-bye… to Variable” urged Canadians to opt for fixed-rate mortgages, saying, “There are mounting signs that the tide is indeed turning for rates, especially with the U.S. economy finally getting back on its feet. Considering the likely upward trend in interest rates as the global recovery picks up speed in 2012, this may be one of those rare periods when a fixed rate turns out to be the superior choice.” With interest rates at historic lows, many Canadians are indeed opting for fixed-rate mortgages, in an effort to lock in a low rate and speed the repayment of their mortgages. A March 2012 CIBC poll conducted by Harris/Decima revealed that half of all Canadians polled said they would go fixed if they had to decide today, compared to only 39 per cent in 2011. As the popularity of fixed rates grows, another question has emerged: How long should you lock in for, five years or 10? As reported by Garry Marr in the Financial Post, the 10-year mortgage accounts for only about 1 per cent of the marketplace, but that may change “as rates for the decade-long term have dropped to an all-time low, with some lenders said to be offering an interest rate of 3.84 per cent.” With rates so low, you might want to consider locking in for as long as you can. As Marr puts it, “the 10-year represents the ultimate in security coming with the heaviest insurance premium — albeit with a much lower cost these days.” One thing the experts seem to agree on is that choosing your mortgage model is a matter of understanding your risk tolerance. Can you afford to roll the dice? Or do you need that extra security? Regardless of your choice, always check to see who’s offering the best rates.