When you are shopping for the best mortgage product, one of the most important considerations is whether to go with a Fixed or Variable rate. While most consumers understand the basic principles, the decision has a much larger impact on the terms and costs associated with your mortgage than simply having a rate locked in for your term, or one that fluctuates along with the Prime Lending Rate. Below, we will highlight both products to help establish the best option for you.
Fixed Rate Mortgages
Fixed rate mortgages are by far the most common choice, with nearly three quarters of Canadians opting for the security of a fixed rate and payment. As the name implies, a fixed rate mortgage will lock in a rate for the entirety of your term. Regardless of whether rates go up, down, or stay the same, your rate will remain unchanged until your mortgage is up for renewal. This security, however, comes at a cost; the penalty to break a fixed rate mortgage is substantial, and can rage from 1%-5% plus of the balance owing (think $5,000-$25,000 to break a $500,000 loan). Given that most consumers will break several mortgages over their lifetime, this should be the biggest consideration you make, despite it being overlooked most of the time. When we consider fixed rates, we recommend working with a lender who offers consumer friendly penalties, and to steer clear of the “big 6 banks” who all charge penalties on the top end of the market.
While all the above could very well be an argument for taking a variable rate, a fixed rate can certainly be the answer in a lot of situations. People on fixed incomes certainly need to know their exact payment and could struggle if their rate and payment increased mid-term. Additionally, if you are at a stage in life where there aren’t many reasons you’d have to break your mortgage, a fixed rate could also be appealing. Paying for weddings, renovations, kids schooling, or moving to a larger home are all common reasons for refinancing or taking a new mortgage. If these aren’t concerns, and you are likely to stay in the same home for the next 5 years, then this could be the way to go.
When leaning toward a fixed rate mortgage, the most important questions to ask are:
· Is this product “Portable”? '
· Is the penalty a “Discounted” or “Standard” interest rate differential?
· Where do I see myself in 2, 3, 4 and 5 years?
· What are my prepayment privileges?
Variable Rate Mortgages
A variable rate mortgage, while less common that a fixed rate, is likely to be the best option provided you take advantage of the rates which are generally lower. In most conversations we have, the common idea is that the fixed is “safe” and the variable rate is “a gamble” – this could not be more untrue. In the vast majority of cases, over the life of your mortgage, taking the variable rate comes out ahead in terms of the cost of borrowing (total expenses, including interest, penalties, fee’s, etc..). Looking at just “interest to interest”, we can see the “gamble” argument, but when you factor in the variable rates generally being lower at the time you take the mortgage, that a variable rate mortgage only costs 3 months of interest to break, and that over 70% of consumers don’t make it past year 3 without breaking their mortgage, that opinion becomes less valid.
We are huge advocates of taking a variable rate mortgage at AHA Mortgages, clearly, but only with the right strategy. We recommend taking a Fixed Payment Variable rate option where you’ll have the best features of a fixed rate (fixed payments), while maintaining the flexibility of the variable rate product.
Even if a Fixed Payment Variable rate product isn’t available, the right strategy makes all the difference. We recommend making the payment equal to today’s 5 yr. fixed rate, to take advantage of the low interest rate, pay down your principal quickly, and hedge against increasing rates in the future. By equalizing your payment to that of the current 5 yr. fixed payment, the entire time your effective variable rate remains below the 5 yr. fixed target, you’re simply adding more and more money to your equity position.
On the other end of things, taking a variable rate for the lower payment alone, is not recommended.
When looking at a variable rate mortgage, the most important questions to ask are:
· Could I afford my payments if they increased?
· Does the lender automatically increase my payments if the rate increases or do my payments remain fixed for the term?
· What “lock in” options are available?
So What Do I Do?
With so much to consider, the quick answer is to talk to a professional. By looking at your short and long-term goals, we can create a plan and account for any potential expenses down the road and ensure you have a thorough understanding of your mortgage. There is no absolute answer on what is right for you, but with the right planning you can be confident in your decision. If you’d like more information or want to start looking for the right mortgage strategy, get started by contacting us at admin@ahamortgages.ca or with a completed contact request form here.
