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The Great Mortgage Debate: Fixed vs Variable Rate

May 2, 2016

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The Great Mortgage Debate: Fixed vs Variable Rate

Planning & Advice

Updated as of Spring 2016

Ah yes. Spring is here. The snow is melting, flowers are starting to grow, but more importantly, it’s real estate season, and a realtor near you will soon be knocking on your door asking again if you’d like to buy or sell.

This is an important time for the banking industry, since a significant amount of their profits are traditionally made on the money they lend in mortgages.

Consumers are getting savvier. Rather than just going to their local bank branch, they’re increasingly shopping around for the best rate or going through a mortgage broker. This makes sense, considering comparison shopping can save a borrower thousands in the long run.

Deciding if you should go variable or fixed can be a tough decision to make. Both options have their advantages and drawbacks.

The Difference Between Variable And Fixed

Fixed Rate: This mortgage is set over a term of usually 1,3,5, or 10 years. During that term, the rate you first sign with will be the rate you pay throughout the term of the mortgage; in other words, there are no surprises. You have a permanent rate and payment that won’t change. This is great for peace of mind, especially when the future holds uncertainty.

The fixed rate is higher than the variable rate, with very few exceptions. Taking a fixed rate over a variable is almost like taking an insurance policy — because it’s predictable, you are taking on much less risk, which is why fixed rates are priced higher.

The fixed rate itself is driven by Canada Bond yields, which are driven by economic factors such as unemployment or inflation. Currently, these 5-year bond yields have flattened, paying less than 1% interest following decades of declines. These declines have driven fixed mortgage rates to some of the lowest rates ever.

The Canadian 5 Year Bond Yield VS Canadian Fixed Mortgage Rates

Mortgage Professionals Canada expects fixed rates to start slowly increasing along with these bond rates. This might be a sign that fixed rates have bottomed out, and the current prices on them are as low as they’ll go.

Variable Rate: Like the fixed rate, these are also set on a 1, 3, 5 or 10-year period, but are priced at a lower rate than the fixed rate mortgages. Why? Because if you go this route, you take on more risk.

Unlike fixed rates, variable rates might change over the term of your mortgage, and can increase or decrease. They too, are driven by economic factors, but your rate isn’t secured. Instead, variable rate mortgages are driven by the Prime Rate. Generally, the Bank of Canada will reduce rates when the economy needs some stimulus, and will raise them when the economy is doing well to control inflation.

The Canadian Prime Rate since 1970 according to the Bank of Canada

Because we don’t have a mortgage rate crystal ball and can’t know if variable rates will increase, decrease, or stay the same, you have to be prepared to take on some risk. Your rate may increase. If that happens, will you still be able to afford to pay it off every month? For one-third of Canadian families, an increase of as little as 1% could mean they will default on their mortgages.

While no one knows what the Bank of Canada will do with their rates, experts say it seems likely rates will remain relatively stable or increase. In addition to that, the Government has warned banks that dropping their rates any lower might spark a housing crisis.

Comparing the Two: Is Either Better?

While it’s possible to save money on a variable rate mortgage (assuming no major rate increases), the difference between fixed and variable rates is not significant as of spring 2016.

Fixed VS Variable Mortgage Rates in Canada since 2008

Consider a hypothetical mortgage of a $500,000 home on a 5-year term, with 20% down (amortized over 20 years). Here is a comparison with rates as of Spring 20161:

Rate Type Lowest Rate Monthly Payment Difference
Fixed 2.37% $1,766/mo
Variable 2.04% $1,702/mo $64/mo

The Verdict For Spring 2016

As you can see, the savings difference on a monthly basis by going variable isn’t too significant at the moment. Given that variable rates are likely to increase over the 5-year term, it might be worth paying the extra $64 a month to have the peace of mind and stability that a fixed rate mortgage offers in this rate environment. This is a growing trend with nearly 66% of Canadians choosing fixed rates right now.

However, this might not apply to everyone, and there isn’t a one-size-fits-all solution. You do have to consider other factors, such as shorter terms or the flexibility you need built into your mortgage. For example, if you sign on to a 5-year fixed mortgage but decide to sell or refinance in 3 years, there could be some hefty fees associated with it.

If you do decide to go variable in hopes of saving some money, perhaps consider opening a high-interest savings account and put away the difference that you would be saving versus a fixed mortgage to mitigate some of the risk of rising rates. This way if rates do go up, you’ll have a cushion to help you pay it off. On the other hand, if rates decrease then you’ll be in a better position in the end.

Watch out for low-interest lenders who require CMHC insurance with 20% down. Some lenders would like to minimize the risk of default and they will require the CMHC insurance regardless of the size of the downpayment. The CMHC premium is a one-time percentage of a mortgage balance, so treat it as ‘hidden’ extra interest. Make sure you are comparing apples-to-apples when comparing interest rates as the advertised rate is only half the story.

A fixed rate looks really attractive at the moment and might be the way to go for many. But if you’re unsure of how to navigate all these possibilities and details, be sure to talk to a reputable professional about what might be best for you based on your situation.


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  1. Source: http://www.ratehub.ca/ 
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