Fixed rate or variable rate mortgage

Should I opt for a fixed rate or variable rate mortgage? Am I better protected if I opt for a fixed rate? Rates are so low now, is it worth it to take a fixed rate for the longest term possible? When we rely on historical data, we pay less with a variable rate, should I go for a variable rate? Here are several questions we’re often asked when we are mortgage brokers.

In addition to the fact that one is fixed and the other varies, there are big differences between the variable rate and the fixed rate. If you think you know all the differences, you might be surprised. I invite you to read the article, you could learn a lot!

Here are the things to take into account before deciding.

Variable rate: belief

I happened to find out that some of my clients thought that the bank had total control of the rate when it comes to the variable rate. As if the bank offered you a variable rate of 2% to attract as many customers as possible, and that one year later it raised its variable rate. This isn’t how it works. Even when we talk about variable rate, there is an element that is fixed. Let me explain it to you.

The reference rate

When they decide what variable rate you will have, all banks rely on the reference rate. Today, July 7th, 2018, the reference rate is 3.7%. This rate is based according to the rate of the Bank of Canada, which is 1.5%. This rate, as well as the reference rate is not very volatile. That is, usually it is rather stable and drops or rises slowly.

The rate differential

A little earlier, I told you about a fixed element in the variable rate. This element is the rate differential offered by lenders. At this moment, the best variable rate found on the market is 2.66%. This 2.66% is determined by the reference rate (3.7%) and the rate differential offered by that lender (1.04%). 3.7%- 1.04% = 2.66%

In the example above, once the mortgage is signed, no matter what happens to the reference rate, your rate differential will always be 1.04%. If the reference rate rises to 3.95%, your new rate will be 2.91%. If your rate drops to 3.45% your rate will be 2.41%.

In other words, the variable rate is not used by the banks to trap you and increase your rate once you have signed.

Now that that is said, compare the advantages and disadvantages of a fixed rate and a variable rate.

Variable rate mortgage: disadvantages

The major disadvantage and, in fact, the only drawback that I can see of the variable rate. It is precisely the fact that it varies. The mortgage is probably your largest payment. So, it is true that it can become troubling to know that it could increase.

Variable rate mortgage: the benefits

There are several advantages in the variable rate mortgage, here are 4.

The variable rate is cheaper

As I said, at the time of writing this article, the lowest variable rate is 2.66%. The 5 year fixed lowest is 3.29%. On a mortgage of $250,000 amortized over 25 years, it represents payments of:
Fixed rate of 3.29%, monthly payment: $1301.53
Variable rate of 2.66%, monthly payment: $1139.93
For a savings of $1301.53-1139.93 = $161.60$
A savings of $161 per month! Of course, this savings could rise or decrease if the reference rate changes.

The variable rate may be fixed

Taking a variable rate does not mean having to stay out in the open throughout the mortgage term. Most of the products can be converted into a fixed rate at any time, free of charge. In other words, if you opt for a variable rate 5 for years, you may benefit from small payments of the variable rate for 2 years. Later, if you’re worried that rates will rise, you could change to a fixed rate during your 5 year term. In this example, you would be entitled to the current rate of the 3 years fixed rate, because after 2 years, it would be 3 years left on your term.
On the other hand, not all banks offer this option and some will charge an administration fee to do it (these famous administrative fees…-_-). The best is to find a mortgage broker to find out.
The penalty for breach of contract on the mortgage is less expensive
This is something that many people are unaware of when they make their choice. The penalty for breach of contract on a variable rate is 3 months’ interest. Let’s take the example of the $250,000 loan. After 2 years you decide to break your mortgage agreement. Depending on the fluctuating rates, you would owe a balance of more or less than $235,000 remaining to be repaid. Let’s say that your rate has gone up to 2.91%. You should pay about $1709.63.
2.91% x $235,000 x 3/12 = $1709.63
In the fixed rate, the penalty is the greater of the following two amounts:

  • 3 months ‘ interest
  • The difference in rate for the remaining term

It’s when the calculation is based on the difference in rate for the remaining term that it can be very high. If, in addition, you did business with a good old bank, it is quite possible it uses the posted rate and not your contract rate to calculate your penalty. This could get you a bill of up to $7,000 or $9,000!

Advice

There are two ways to protect oneself from excessive fees from a breach of contract, take a variable rate. Or doing business with a virtual lender that calculates the penalty on the contractual rate and not the posted rate.

Fixed rate mortgage: disadvantages

More expensive

As we saw before, the fixed rate is more expensive than the variable rate. In addition, in the event of a breach of a mortgage contract, the penalty can skyrocket. Therefore, we are protected from a possible rate increase, but not against the life events that could force us to move. Change/loss of employment, new unexpected child, divorce, needs that change over time…

Fixed rate mortgage: the benefits

Peace of mind

The major advantage of the fixed rate is that it protects you in the event of a fairly drastic rise in rates. I say drastic, because if the variable rate doesn’t rise higher than the fixed rate, you would still pay less with the variable. With today’s rates, the variable rate would therefore have to rise more than 0.63% (3.29% – 2.66% = 0.63%) to get you to pay more with the variable.
Such an increase over a period of 5 years is possible. So, if you think that taking a variable rate would prevent you from sleeping, it’s worth it to buy your peace of mind with a fixed rate.

In conclusion

In the end, whether in this text or when I meet with clients, I’m not trying to convince my clients to take one or the other. It’s their decision; I understand it and respect it always. However, before making a decision, I consider that it is crucial that you are aware of all the elements that differentiate the fixed rate from the variable rate. Remember that the fixed rate, just as the variable rate, have their advantages. Depending on the situation, one may be better suited than the other.
And you, are you more of the type to choose the fixed rate or variable rate? Why?

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