Variable vs. Fixed Mortgages

The most common question is “fixed or variable – which is my best option?” An easy question should provide an easy answer, right? Well, there’s a lot to consider on the client’s behalf. The difference between a fixed and a variable rate is like trying to compare apples to oranges. They each serve a different function.

When dealing with Variable Rate Mortgages (VRM), the idea of a “set payment” plan is not the intent. The intent is to “float” an interest rate according to what the prime rate of Canada is doing. We know that with experiencing historically low interest rates, that a VRM has very beneficial factors. With the Prime Rate of Canada being at 5.25% today, and lenders being competitive in offering below prime rates in the products they offer, a variable rate mortgage seems easily justified.

Today’s most common variable rate mortgage has an interest rate of .60% above prime on a five-year term! Yes, that 4.75% as a monthly payment! Take a mortgage of $150,000 and today’s VRM rate of 3.85%. On a monthly basis your payment is $814.95. Not bad. In fact it’s very, very good.

Herein lies the question, “why isn’t EVERYONE taking a variable rate mortgage”? Seems simple enough… the prime rate of Canada stays low, and my interest payments stay low as well. Ah-Ah! There’s no guarantee that we will stay at these “all time lows” in interest rates. However, all hope in security is not lost when choosing this type of mortgage. The lenders have a “lock in” feature set up within this program that allows you to lock in to their fixed rate mortgage at any time, without penalty. Hey, not bad. It is typical for the banks to set the payment at each month. So, that is to say that if your payment at the start of the month was based on a 5.50% interest rate, it will stay that way until it is set again the following month.

What about prepayment options and prepayment penalties? Usually you can find a bank that will allow prepayment options attached to their variable rate products. If you decide to set your payments to reflect a higher interest rate, the difference between the two payments goes directly to your principle each month. Even better. That has potential to save you YEARS off the amortization of your mortgage.

The prepayment penalty for a variable rate mortgage (breaking the mortgage), is three –months interest payments. When trying to decipher how a VRM works, think of a mutual fund. Your payments can fluctuate from month to month. Although you are floating below prime, there is not set payment from month to month.

A fixed rate mortgage (or commonly referred to as a “closed” mortgage), is set up so that you have “fixed “, payments as every month (or bi-weekly, etc). There is no guessing as to what your next mortgage payment is going to be from month to month. For example, you have a $150,000 mortgage and you have an interest rate of 6% over a 5 year fixed term. You know that if you pay the minimum payment per month, your payments will be $950.41 (principle and interest only) for the next fiver years. That’s the security of having a fixed rate.

This type of mortgage may be most attractive for the client who may have a set income, example a pensioner, or a disability fixed income. The fixed rate mortgage is also designed for security in knowing a payment structure and for the purpose of piece of mind.

As far as deciding what’s best for you, there’s no right or wrong answer! It all depends on a risk and security factor that you’re comfortable with. Everyone has their own idea of “how to get ahead of the game” and how their monthly finances work within their household. Talking to us just may help you find your strategy in YOUR games