In April 2008 (only months before the credit crunch) an article written by Keith Woolhouse, Special to the Star, addressed the age old question “variable or fixed?” Since then borrowers with discounted variable rate mortgages have saved thousands of dollars in interest.
Woolhouse compares the two types of borrowers; the fixed rate camp, seeking security versus the variable rate camp, who are prepared to gamble. While monthly payment plays a part in making this decision, the greatest motivator is the risk factor. It’s the ultimate gamble and why an estimated 70 per cent of Canadians opt for the fixed-rate mortgage believing that not only will they sleep better but they are making the best decision. After all, this is likely the biggest investment in their life.
However, statistics show that nearly 85 to 90 per cent of the time, borrowers save money by choosing a variable rate mortgage. Borrowers should not make any decision based on speculating interest rates but rather on their personal risk tolerance. One need only take a look at the past to know that the prime lending rate can and will change. In May 2006 the prime lending rate was 6%, rising to 6.25% in July 2007 before it dropped below 6% again in January 2008 and continued to drop to 2% before rising to 3% in 2011 where it sits today. Over that same time period from 2008 – 2013 5 year fixed rates have changed from 5.25% down to 2.79% and up to 3.39-3.79% where they sit today.
In response to economic instability in Oct 2008, lenders changed the variable rate product from prime minus .6% to prime plus 1%. Within a couple of years discounts returned to P-.8% for a short period of time and have returned to P-.4% range in 2013. For some borrowers who are familiar and comfortable with a variable rate product this change in rate structure may not matter as they prefer the potential upside – as the prime rate drops they pay less interest and more principal off on their mortgage. However, for those risk-averse borrowers or first time home buyers with little equity in their home, the potential downside could prove to be too much to handle. In 2011 the spread between 5 year variable or fixed was less than 20 basis points at times so the choice between variable or fixed was an easy one. There was no need to choose variable and take the risk of a shift in the prime lending rate when you could secure a low fixed rate. However, today that gap has increased to 80 basis points and growing. So the choice between variable or fixed may not be as easy.
If you are ready to purchase or remortgage and unclear on which is the right choice for you, ask yourself a simple question. “What would happen if the prime rate rose to 6% again and my mortgage payments rose? Could I afford it?” That potential change translates to $120 per month for every $100,000 based on a 25 year amortization. If you are able to ride the wave up and down the odds are you will save money in the long-run. However, you have to be able to take the hit if rates rise. If you are unsure – then it may be best to take that fixed term rate. Either way, when your term is up you get to decide all over again.