Variable or Fixed? an update on how to choose.

FIXED OR VARIABLE?

The debate over fixed vs variable never seems to end.   For the past 5 years, the Federal govt and the BIG SIX BANKS have been doing everything in their power to force us into choosing a 5 year Fixed rate.    The govt says it gives us security and protection against the anticipated interest rate hikes.   BANKS jumped on this bandwagon because 5 yr fixed is the most profitable mortgage product.. and with fixed rates hovering at 3.00% for the last 3 years, it’s been an easy sell.

On the surface, it’s not bad advice.    Fixed rates were supposed to go up.   The spread between Fixed and Variable has been less than 1.00% over the last 3 years.     My rule of thumb is that Variable rates should be 1.00% lower than 5 yr fixed in order to benefit from the possible rate fluctuations.   So naturally, 5 yr fixed was a better choice.

DO YOU TRUST YOUR GOVT AND YOUR BANK?

Well, not really.  If you chose a Variable rate at any time during the last 12 years, you would be a clear winner.  In fact, if you chose a Variable rate at any time over the past 30 years, you would be a winner.   That’s right, your overall average rate would be lower than compared with the overall average 5 yr fixed rate.

Having said all that, when the spread dropped to 0.50%, it’s hard for me to recommend choosing Variable for everyone.   That’s because we need to remember the emotional side of things.   If you can’t sleep at night because you notice every article or report about the impending rate hikes, then go with a Fixed rate.  I think there is something to be said for having peace of mind.  You just need to understand the cost and you need to be in the right product.

But if you understand that current economic conditions and forecasts by the Bank of Canada are calling for rates to remain low for some time to come, then consider choosing a Variable rate.    Saving 0.50% adds up to around $1,100 per year on a $300,000 mortgage.  So choosing a Variable can and still does make sense.

MORE PRODUCT DIFFERENCES

There’s another phenomenon.   New NO FRILLS Variable and Fixed rate products have come to the Canadian market.   You won’t see them advertised as ‘NO FRILLS’ products.  The products typically carry a slightly lower rate and attract a lot of attention.  However, these products should be avoided.   Saving 0.05% or 0.15% isn’t gonna make or break you.   But the restrictions, limitations and inflated penalty calculations will.  In the end, these products will usually end up costing you more down the road.  Signing a mortgage contract isn’t something to be taken lightly.

One of the biggest mysteries about mortgages was how the penalties were calculated.   In recent years, we’ve seen them skyrocket to $30,000, $40,000 and more.  And this is being charged by the BIG SIX BANKS… not some obscure financial institution.    If you aren’t sure how a penalty is calculated, ask questions.. and if you are still unsure, speak with an experienced Mortgage Broker.

One of the most important features to have in a Variable rate mortgage is the option to lock into the BEST discounted fixed rate that the lender has to offer at the time of lock in.   Again, this is something most of us don’t think about, but it’s critical.

BOTTOM LINE

Variable rate is still the clear winner even with fixed rates being in record low territory.    Incredible to say but it’s true.  Just be ready… you may need to lock into a fixed rate at some point… and you better have the option to lock into the BEST discounted rate… don’t be counting anything your Banker or Broker promised.   Get it in writing.  We may be making that call in the future.  For now, it doesn’t appear to be urgent.

Your best interest is my only interest.   I reply to all questions and I welcome your comments.  Like this article?  Share with a friend.

Steve Garganis 416 224 0114 steve@mortgagenow.ca