Should you choose a fixed rate mortgage or variable rate mortgage?
If you’re getting a mortgage, you’re going to need to answer that question. But it can be confusing.
Which actually gives you the best deal? Here we are going to examine a 5 year mortgage, comparing fixed rate and variable rate options, in order to help you make sense of what this actually means for you.
Fixed Rate versus Variable Rate Mortgages
First, let’s review what these terms mean.
A fixed rate mortgage gives you a set interest rate and this rate is stabilized across the term of your loan. So, for example, if you qualify for a 3.19% fixed rate mortgage on a 5 year loan then your interest rate is set and, by the terms of the agreement, will not change during the 5 year period of your loan.
Variable rate mortgages, on the other hand, are pegged to the bank’s prime rate. If the prime rate goes up or down, your mortgage rate goes up or down. But don’t worry, the prime rate doesn’t change very often. So for example, if you start out with a 2.50% variable rate and the bank raises their prime by 0.10%, your rate goes to 2.60%.
Well, that makes it easy, doesn’t it? Fixed rate mortgages seem better, don’t they? There’s a sense of stability in the idea of no changes. But it’s not that simple.
The Truth about Variable Rate Mortgages
In 2001 a study showed that almost 90% of Canadians would have seen better overall performance on their mortgages if they had a variable rate as opposed to fixed rate option. This wasn’t a short trend across time, either. The study looked at the years 1950 through 2000. That’s a significant chunk of time, with a significant result.
There are times when interest rates spike, of course. In the late 1980’s and early 1990’s we saw a rate hike that stands out as significantly different from the average trend seen through the last half of the 1900’s. But overall the trend shows favorable preference towards variable rate mortgages.
In a variable rate mortgage, interest rates reflect the trends set by the central bank. This means you can be guaranteed of fluctuations over the course of your loan; however, it’s important to understand changes don’t have to be scary. People often assume the trend will be upwards when it comes to interest rates, which is the reason why so many avoid variable rate mortgages for the perceived stability of a fixed rate mortgage. But this also means you don’t benefit when the interest rates go down.
Don’t be a Sucker
Looking at a 5 year mortgage means you’re really, really close to being debt-free. With this kind of a situation the benefits you could reap from a variable rate mortgage are even greater. Don’t let bank officials or friends or family influence this decision for you. After all, it’s your money that will be spent on your mortgage; make the choice that’s right for you.
The benefits of a fixed rate mortgage come in the locking in of an interest rate for the life of the loan. This sounds secure, safe, and predictable. But it overlooks the immediate and long-term benefits of choosing adjustable interest rates over fixed. With a variable rate mortgage you can get immediate benefits because these loans often start out at a lower interest rate. Over the course of the loan the rate will change, but it frequently sees declines, which is an advantage that a fixed rate mortgage will never give you.
Don’t rush into any decision without the right information. Factors to consider include: how often will your interest rates be subject to adjustment; how high could your monthly payments climb; how quickly will rate adjustments take affect; is there a maximum amount (a cap) on the interest rate adjustment; is there a minimum amount for the interest rate adjustment; and, given all of these conditions, will you continue to be able to afford the required payments for your mortgage over the life of the loan period?
Looking at a 5 year loan period indicates you’re likely to reap major benefits from what a variable rate loan can offer you.
Properly examine your mortgage options. Calculate your financial health. If your budget can accommodate the potential fluctuations over the course of the loan – especially when your loan length is as short as 5 years – it’s a very good idea to choose variable rate over fixed rate. If you have further questions or remain uncertain about which mortgage options present the best options for you then don’t hesitate to give me a call! This is what I do, and I’m passionate about it!