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Should You Get a Fixed or Variable Rate Mortgage?

One of the biggest questions that you have to answer when you buy a home is whether to choose a fixed or variable rate mortgage. As with all things personal finance, you need to figure out which mortgage rate works best for you.

What is a Variable Rate Mortgage?

While variable rate mortgages have been available in the United States for much longer, they have only been widely available in Canada since the 1990s.

These mortgages are those in which the mortgage rate changes periodically. Instead of locking in a rate for the entire term of the loan, the mortgage rate changes with the market rates. In many cases, a variable rate starts out lower than a fixed rate, since there is the potential for the rate to rise over time. This means that your mortgage payment can change several times until you pay it off. A fixed rate ensures that your mortgage payment remains the same throughout the entire term of your loan.

Interestingly, a variable mortgage rate might provide you with a better outcome than a fixed rate. A report released in 2001 states that, historically, variable rate mortgages at prime have benefited borrowers 88.6% of the time over the fixed rate. Obviously borrowers who have rates of less than prime are even better off.

This historical savings is the risk premium; the return in excess of the risk-free rate of return, which is the fixed rate.

But Could a Fixed Rate Be Better Right Now?

Historically, a variable rate has been better overall for Canadian home buyers. This is because at the time of the study, rates were higher relative to now. The market has changed, so if you’re looking for a mortgage right now, it may be one of those few time periods where a fixed rate mortgage may be a better deal than a variable rate, at least over time.

Canadian mortgages are coming with longer terms, influenced by the way things work in the United States. This means that locking in at a low rate now, especially if you have a longer term loan, can help you avoid interest rate increases later.

On the other hand, the Bank of Canada doesn’t show any signs of raising its benchmark soon, and there are worries that the housing market is in a bubble. When you you think about the situation in those terms, it might actually make sense to go with a variable rate mortgage right now, especially if you get a 5 year loan.

Take a look at your individual situation, and run the numbers. Also, consider what you think is likely to happen in the next few years. Will conditions mean that mortgage rates rise before you can do something different with your loan?

Unfortunately, there is no predicting the future, and no sure way to ensure that you are doing what best for your mortgage situation right now. Think about your cash flow, and whether you prefer a fixed payment to a variable payment, and then get the mortgage that works best for you.

Comments

  1. Silicon Prairie

    I agree that this is a big consideration. Predictions over that time period aren’t worth much, but rates can go up 5% a lot more easily than they can go down 5%.

    I don’t know if the fact that variable rates are now set to be higher than prime rates makes a difference – by the time they come down again the interest rates might have already gone up – but that’s another issue. Even if rates do go up, geting a mortgage now could add 1% to your interest rate for the whole term.

  2. John [email protected] refinance rates

    It’s great reading this information from other countries around the world. All the trends seem to be going a similar way in many countries including Australia. Thanks for the post.

  3. Right now I have to think fixed rates are the instinctive choice. They’re below 5% and haven’t been this low since the 1930s!
    Now would be the time to lock these rates in.

    The reason people have benefited from ARMs in the majority of cases is that rates have been falling for the past 25 years. A reversal of the trend- a 10 or 20 year trend toward rising rates – would put holders of ARMs in the worst possible position.

    When I got into the mortgage business, people were taking ARMs as relief from rates above 15%. Why would anyone do that with fixed rates below 5%??? (???)

  4. Chris Martin

    I’m currently looking to buy a home and have decided to go with a 10 year fixed @ 5.45. I’ve figured that with the early payment options I can have it paid off in full within 8 years anyway. To lock in such a low rate gives me security for a decade should I get laid off again. When applying they try to push a 6 month convertible on you. It’s obviously a trap as I know as well as they do that 6 months from now interest rates will be on the rise. Alarm bells rang because of the tenacity with which they were selling this 6 month variable to 5 year fixed option.

    • Tom Drake

      Chris,
      It will certainly be interesting to see what the rates do in the future, only then will we know for sure if we both made the right choice. My guess is that we did!

  5. Don

    especially in these financial times it is a good idea to research what banks are offering and find the best fixed rate mortgage with the lowest interest rate. If you are unsure about some of the procedures with the mortgage re-payments talk to a independent advisor or find out more information on this site.

  6. Sue

    I understand and agree with the info above. But right now I am looking for advice about if or when I should switch from the variable rate mortgage I already have to a fixed rate. We bought the house just under 2 years ago. The variable rate is prime minus .25%, so right now our interest rate is 1.9. What was originally set up as a 40-year mortgage now has less than 20 years remaining. But if interest rates go up again, the remaining time on the mortgage will increase, and depending how high they go, the payment may need to be increased to compensate. Common sense says interest rates will not go lower. My question is, if we are still benefitting from the lower, variable rate, how much higher should I let them go before we lock in??

  7. Ken

    I would say be patient. Don’t let fear mongering dictate your financial decisions. Look if your at 1.9 and it goes up 50 basis points your still only at 2.4. Thats way better than 5%. Yes the rates will probably go up a bit. But their not goin to go through the roof. I just signed a 3 year varialble rate mortgage @ 1.85…Since then it actually went down to 1.75 !! I have the option to go to a fixed rate mortgage WITHOUT penalty any time during the life of the mortgage. Don’t jump off the VRM too quickly. Sit down with a broker and get some advice.

  8. anand

    we so much consult about the mortgage and all the thing related to that
    ====================
    Mortgage Broker

  9. Nolan Gatts

    Hello There.We are a small group of community folk and are opening a new scheme in our community. Your site provided us valuable insight to work on. You’ve done a formidable job and our entire community will be grateful to you. Thank you, very much.

  10. Gregg Singer

    I suppose if you need a long time limit for your loan you should go with a fixed rate or if you want a mortgage loan for small time you should go with variable rate. But both are depend on amount of loan too respectively. So, be calm when you will choose the plan for mortgage loan.

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