With home prices in Toronto and Vancouver seemingly going up thousands of dollars per month, many Canadian buyers are desperately seeking to buy houses, worried the market will zoom by and they’ll be stuck renting forever.
Meanwhile, millions of current home owners are faced with a dilemma. With mortgage rates at record lows, they’re tempted to lock in today’s enticing rates for the next five years. But variable rates are still cheaper than fixed, and interest rates don’t look like they’ll increase anytime soon, at least here in Canada.
So there are compelling arguments for homeowners to choose both fixed-rate or variable-rate mortgages. Here’s how these folks can figure out which is best for them.
Other factors to consider
The first thing mortgage holders should consider is their overall financial situation.
Choosing a variable rate will save money over the short-term, there’s no doubt about that. But those savings come with a healthy amount of uncertainty. What if rates shoot up and the payment goes higher?
Lenders have helped protect against that, introducing variable mortgages that keep the payment the same no matter what interest rates do over a five-year term. The kicker is this product is generally only available to people who can afford a hike in interest rates.
Increasingly, people are opting for variable rates because they barely qualify for a mortgage. They’ll gladly exchange the risk of higher rates in the future for lower payments today because a smaller payment is a very big deal to them right now.
These people probably shouldn’t be in variable rate loans to begin with. If you’re one of them, I’d suggest a fixed-rate mortgage. Yes, it’ll cost more day one, but at least there’s no risk of the payment going up. Or, better yet, these folks should be in a variable rate mortgage with payment protection.
What about folks who can afford whatever?
For most people, the fixed vs. variable debate comes down to one factor.
What is the insurance of having a steady rate worth to them?
These days, the spread between five-year fixed and variable rates is approximately 0.5% annually. Some mortgage brokers are offering lower fixed rates, but the 0.5% seems to be about the average.
Over the five year term of a mortgage worth $300,000, choosing the fixed option is worth about $7,500 more in interest compared to the variable option–assuming rates stay constant throughout. We’ve seen variable rates fall in Canada over the last two years. If the trend continues, the difference between the two types of loans gets even bigger over the span of the next five years.
In exchange for taking on this risk, folks get protection in case rates to start to creep higher. Although that might seem unlikely at this point, a lot can happen over the next handful of years. People who got a mortgage in 2004 renewed in 2009. The world had completely changed in those five years.
Ultimately, insurance costs money. If doesn’t matter if that insurance is for a house, vehicle, or on your life. Getting a fixed-rate mortgage is a form of insurance, and that always has a cost associated with it.
Remember, not all mortgages are five years
Not everybody should be in a five-year mortgage.
The big group that shouldn’t are those who are thinking of moving relatively soon. Payout penalties are highest for longer loans. If moving is something that’s crossed your mind, stick with terms of three years or less.
Shorter terms can also serve as a nice hybrid between fixed and variable rates. The cost of a three-year mortgage usually ends up about midway between the cost of a five-year variable and a five-year fixed rate. This can be a nice compromise between the two.
Ultimately, going with a pure variable mortgage will likely save you money, like it has for the last decade. But with rates at all-time lows, it’s easy to say locking in isn’t the worst idea in the world. Personally I’d go with variable over fixed, but still can’t really fault anyone who chooses to pay a little more for the insurance of a fixed rate.