Recently, we came across an observation made by Janet Yellen, United States Secretary of the Treasury, who stated: “Housing wealth – the net equity held by households, consisting of the value of their homes minus their mortgage debt – is the most important source of wealth for all but those at the very top.”
The comment led us to start thinking about the classic conundrum of resolving the relative advantages of variable and fixed rate mortgages, particularly since the gap between variable and fixed interest rates continues to shrink.
Implications of Interest Rates Hikes
The latest Bank of Canada rate increase means those people in the market for a mortgage probably want clarity on the issues to consider when hunting for a home loan.
A couple of years ago this issue was pretty much a no-brainer. Inflationary pressure barely existed and, as a result, the variable option was the outright winner for most of us compared to the fixed alternative.
But with more interest rate hikes anticipated as part of Canada’s central bank commitment to combat inflation, prospective buyers and homeowners looking to renew their mortgage loan will likely view the fixed-rate mortgage option – which locks in your rate over the length of the loan term – more sympathetically.
Mortgage Rates Are Cyclical
As an article in The Globe and Mail reported recently: “One truism about mortgage rates is that they’re cyclical. When the Bank of Canada is done dishing out pain to borrowers, inflation will subside, the economy will stall, and rates will drift back down. It’s mainly a matter of when. And that’s the thing. With average core inflation at a record high, no one knows how much higher rates need to climb to drive inflation back to its 2 per cent target.”
Choose What’s Best for You
Fixed rates on mortgages are rising, so choosing between the alternatives is tricky.
What follows are some pointers – not, we hasten to add, personalized recommendations – to help you open a discussion with a mortgage professional at your credit union, should you wish to do so.
Especially for first-time buyers, a fixed rate mortgage offers the reassurance of certainty about monthly payments and interest paid on the debt.
This degree of reassurance is good news for those with high debt challenges. If the potential for extra mortgage costs might undermine your budget, then locking in a fixed-rate mortgage is a smart strategy. But don’t forget to shop around. The mortgage market remains competitive, and lenders are aggressive in their quest for new business.
Variable Rate Mortgage
Rates might be rising, but even in a rising rate world a variable rate mortgage can make sense for some homeowners. It just depends on the specifics of your situation.
While real estate acquisition is usually seen as a long-term decision, that’s not always the case. So, if moving on – let’s say after five years – is part of your plan, then a variable rate mortgage is eminently justifiable. Ask your advisor for guidance before making this choice.
A Key Difference
A broken fixed-rate mortgage results in a penalty, typically calculated using what’s known as the Interest Rate Differential (IRD), and that penalty can be costly.
A variable rate mortgage can usually be broken at any time (in order to convert it to a fixed rate, typically) and you’ll only be liable for a few months’ interest in pre-payment penalties. It’s easier to bear.
What Else Is Out There to Choose From?
Let’s say, alternatively, that you’ve decided to adopt a pay down my mortgage as fast as I can strategy – instead of opting for either a fixed-rate or a variable rate mortgage. If this is the case, you may be interested in what was reported in the Financial Post recently:
“Another good reason to select a variable rate mortgage is to capitalize on the lower monthly mortgage payment and use it to your advantage. At the start of June , the best five-year fixed rate was 3.69%, compared to a five-year variable rate of 2.25%. On a $700,000 mortgage, these monthly mortgage payments work out to $3,565 versus $3,049.
After five years, the borrower with the fixed-rate mortgage would still owe $606,044 in mortgage debt. However, if they opted for the variable rate mortgage but paid the fixed-rate monthly payment, after five years they’d owe $556,728 (assuming no change in interest during that time). That extra payment on the variable rate mortgage reduced your overall mortgage by almost $50,000 over the five-year term.”
That said, the gap between fixed and variable interest rates has tightened dramatically in previous months and even weeks—meaning, look at the numbers and determine how true this advice continues to be.
Ultimately, It’s About Your Appetite for Risk
As with most investment issues, risk – a behavioural as well as a financial consideration – is what your decision will likely be driven by.
- If you’re worried about rising rates and prefer to know exactly what you’re paying each month, a fixed-rate mortgage is best
- If you’re more comfortable with taking on risks or have a plan to add extra payments to the mortgage, a variable-rate mortgage can be ideal
Get Expert Mortgage Advice Now
As with any kind of loan, there’s more to consider than just a great rate. And that’s where your local credit union can help. They’re good with personalised advice, guidance, and answers to questions you didn’t even know you had. They’re also honest and sympathetic.
And they can certainly help you resolve other mortgage issues such as open versus closed mortgages, prepayment options and the availability of the increasingly popular mortgage payment vacations.
Most credit unions offer an online mortgage platform, which enables you to clarify all their mortgage issues and options with convenience and speed. If you prefer a more hands-on approach, a mortgage professional at your credit union will be happy to meet with you personally.
We hope this helps!