FIXED or VARIABLE RATE?
Possibly the #2 question asked most often after mortgage rate, identifying whether a fixed or variable rate product is best for you is an important step in the overall financing process.Although we all wish a crystal ball would show up at our doorstep, the truth is that no one can accurately forecast what will happen in the financial markets 3 to 5 years from now.
So assessing whether a fixed or variable rate mortgage product is best for you rests in an understanding of your own financial plan and ability to handle market fluctuations (risk tolerance).
Over the many years that I’ve been negotiating my own mortgages, mortgage renewals, and contemplating where we are in the rate cycle, I found a very simple test to help answer this very question:
If the possibility of a quarter-point increase in interest rates will cause you to lose sleep at night or cause undue stress on your monthly budget, it’s time to consider a fixed rate mortgage.
Here are some things to consider:
Fixed Interest Rate
A predetermined interest rate that will not change during the term of your mortgage, thereby buffering you from increases in market interest rate. A fixed interest rate is often higher than a variable rate. It does not matter if interest rates go up or go down; your rate is fixed, and your payment is fixed.
Fixed rates are based on the yield on Canadian government bonds. The yield is essentially a minimum rate of return required by investors who trade government bonds. Fixed mortgage interest rates are strongly correlated with Canadian bond rates of similar term of maturity, meaning that any change in government bond rates eventually translates into a similar change in fixed mortgage rates.
Variable Rate Mortgage
Variable rate mortgages fluctuate with the banks prime-lending rate. Variable rates are essentially determined by institutional prime lending rates, which are influenced by the Bank of Canada’s key interest rate. The discount or surcharge on prime that you receive can fluctuate with market conditions and what each lender is offering at any given time.
Some basic questions to determine if a variable rate mortgage for you?
- Do you have room factored into your budget if your payments were to go up?
- Do you follow the rates to know if or when you should lock into a fixed product?
- What would your rate be if you chose to lock in at some point? Is that discount in line with the wholesale rates available in the market?
If it is a certain discount off of the going rate, is it in line with what is being discounted today on that product?
Keep in mind:
If you are a first-time homebuyer with a high ratio mortgage and you are looking to take a variable interest rate mortgage, you will need to qualify at the 5-year rate as posted by the Bank of Canada interest rate. This means that you must have the financial tolerance to afford the monthly payments as if you were applying for a 5-year fixed interest rate mortgage. This change in qualifying rules was initiated by the federal government to help ensure that first-time homebuyers remain capable of managing increased monthly mortgage payments in the event interest rates increase considerably.
Which one should you choose?
If you’re a person who would lose sleep wondering how your monthly budget and mortgage payments would be impacted if interest rates went up by a percentage or two, then having a fixed interest rate mortgage is probably for you. If you’re a person who can cope with unpredictability and believe that over the long term you’ll come out ahead (i.e., more green in your jeans), a variable interest rate mortgage may be the right choice for you.
Once you lock in your mortgage, you may pay a penalty if you try to refinance or payout your mortgage early.
Penalties often equal about three months interest or the interest rate differential, whichever is greater.
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