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Fixed Rate vs Variable Rate
Most mortgage shoppers when left to make their own mortgage choices will generally choose a mortgage that not in their best interest. When they go to the banks they let the bank employee decide for them. When they make a suggestion do you think it will be the mortgage that make them and the bank’s shareholders the least amount of money or more money? Unless you ask for something specific they will offer you the 5 year fixed.
The rationale behind that term is that you can budget every month for 5 years as you know exactly what your payment is going to be or the peace of mind suggestion you can sleep at nights knowing that your rates won’t go up midterm.
I am going to compare the 5 year fixed rate mortgage and a 5 year variable rate mortgages and you can decide which is more beneficial to your mortgage and financial planning. I am not a financial advisor so I am not advocating any long term financial plan except for mortgage planning.
A 5 year fixed rate mortgage is the mortgage of choice for most Canadians because;
They provide payment stability Rate is set for the term of the mortgage Know what your mortgage balance will be at the end of the term.
One major downside is the penalty that could be charged for an early discharge of a 5 year fixed. Depending on the outstanding balance at the time of early discharge this could be as much as forty thousand dollars or more.
A 5 year variable rate mortgage is tied to the Bank of Canada (BOC) rate and is set at your mortgage lender’s prime rate less a discount or plus a premium. These days it’s being offered at a discount. Some advantages of being in a variable rate mortgage:
Typically much lower than a 5 year fixed rate mortgage If rates go down, your principal payment increases Can convert to a fixed rate mortgage Three months interest penalty on early discharge Less interest charges over the life of the mortgage Mortgage paid off faster.
Many Canadian economic expert including Dr. Moshe Milevsky, Associate Professor of Finance at York University found that choosing a variable mortgage between 1950 and 2007:
1. Would save Canadians about $20,000.00 over 15 years on a $100,000.00 mortgage, and,2. Variable rate mortgage saved Canadians more 89% of the time compared to a fixed rate
mortgage
One disadvantage of the variable rate mortgage the rates aren’t guaranteed for the term of the mortgage as the rate can either go up or down. This is usually caused by economic activities that the BOC monitors to prevent inflation or deflation.
Below are two charts, one compares a 5 year term (fixed and variable) mortgage amortized over 30 years using an accelerated bi-weekly payment schedule. The other compared two variable rate with the same rate but only one uses the saving by not taking the 5 year fixed to make extra monthly payments. This assumes there is no mortgage default insurance. Of course the main factor is the rate which determines the payment and how much is split between the principal payment and the interest payment. Because the variable rate mortgage interest rate is lower more of the payment will go to the principal and over this period (5 years). The faster the principal goes down the less interest is paid and even though there is a difference of 2,436.83 in the mortgage balance there would be 8,253.05 more in interest payments.
In the first chart there is $5,826.80 less payment going towards the variable rate mortgage while there is $2, 426.45 more and reducing the principal more by $8,253.05. So clearly assuming that rates don’t change during the 5 years having a variable rate is a better option than the fixed rate mortgage.
As I mentioned earlier if the prime rate increases and it usually does by .25% and very rarely if ever by .50%. Should that happen, you do have the option to switch to a 5 year fixed rate mortgage at the current rate that is being offered by your mortgage lender.
Fixed Rate vs. Variable Rate
Mortgage Type
Mortgage Amount Rate
Bi-weeklyPayment
TotalPayments
Principal Payments
Interest Payments
Mortgage Balance
5 Yr. Fixed 400,000.00 2.59 798.19 103,763.40 55,754.66 48,008.74 344,245.345 Yr. variable 400,000.00 2.15 753.36 97,936.80 58,181.11 39,755.69 341,818.89Difference 5,826.60 2,426.45 8,253.05 2,426.45
Assuming that you want to make the 5 year fixed payment amount but decide to take the variable rate mortgage, you could do that as well. In the example the difference between the fixed rate payment and the variable rate payment is $44.83 and you could prepay your mortgage by this amount with each mortgage payment (this payment amount is used for illustration as the minimum prepayment amount lenders accept is $100.00 per prepayment).
Variable Rate vs. Variable Rate with Extra Payment
Mortgage Type
Mortgage Amount Rate
Bi-weekly Payment
Total Payment
Principal Payment
Interest Payment
Mortgage Balance
5 Yr. Fixed 400,000.00 2.59 798.19 103,763.40 58,181.11 48,008.74 344,245.345 Yr. variable 400,000.00 2.15 798.19 103,763.40 64,354.22 39,409.18 335,645.78Difference 44.83 ----------- 6,173.11 8,599.56 8,599.56
In this case the difference between the 5 year fixed and the variable while making the same payments show a difference of $8,599.56 in mortgage balance over the 5 years and $6,173.11 going directly
towards the principal and goes to show that there is more benefit in taking a variable rate mortgage than a fixed rate product.
The drawback that most borrowers have in taking a variable as opposed to a fixed rate is understanding how to interpret the financial information that is spewed from the various news medium and how it affects their rates and mortgage term. The banks are trusted institutions but they have a vested interest in how they advise. I will admit that I have a vested interest in every mortgage I assist in facilitating and although I have a fiduciary responsibility to the lender borrowers tend to be less informed and need more guidance so there is more responsibility in assisting them in reaching their financial goals and selecting the best mortgage for them as their lifestyle and goals chances.
I work with my clients with these decisions and I would be more than happy to help you as well. Please call me at 1-855-227-5663 or email [email protected] if you have a mortgage question or for more information about this communication.
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Devon Jones, Mortgage AgentDominion Lending Centres Altra Inc.335 Bayly Street, Ajax, OntarioL1S [email protected]
