Fixed vs. Variable Rates: Which is Best?
To get anywhere, or even to live a long time, a person has to guess, and guess right, over and over again, without enough data for a logical answer. – Robert Heinlei
I love this quote. It really speaks to what product should I take in order to save the most amount of interest paid on my mortgage? Mortgage rates are remaining at all-time lows for an extended length of time these days. I heard the term stable “instability” is what we are experiencing. (If there is such a thing) But to understand the best choice we really need to understand the Pros and Cons mixed in with a bit of educated guessing about where rates will go over the longer term.
It is all very confusing…
Some people to say rates have only one way to go from here (up). Some people to say rates will stay flat for two years. Some people to say rates will drop again soon.
All of this to speak to the ever increasing uncertainty out there these days. So let’s review the Pros and Cons together.
“Variable Rates”: Why Go Variable?
Statistics, Statistics: 77% of the time, variable wins – historically speaking. That’s according to the usually widely-quoted mortgage research
Lower Penalties: People often break their mortgages early, for various reasons (including refinancing, selling, divorce, moving to a mortgage with a better rate/more flexibility, etc.). The average duration of a 5-year variable is about 3.3 years according to bank sources.
Less Rate Risk: Compared to prior economic recoveries, economists believe that it won’t take as many rate hikes to cool Canada’s overleveraged slow-growth economy this time around.
Slower Rate Hikes: CIBC economist Benjamin Tal says: “We know the five-year (fixed) rate is attractive, but we also know short-term rates are not rising.”
A Free Option: Variables let you lock in anytime for free. I am a big proponent of variables largely for this reason. “If you have huge vacillations in rates and you want to take advantage of those (i.e., lock in if rates drop further, or lock in if rates look like they’ll blast off), you can do it for free in a variable rate…but not in a fixed
Fixed Payments: Some lenders let you fix your payments so that they don’t move when prime rate moves. Fixed payments, therefore, provide some peace of mind when rates start climbing.
Payment Matching: When variable rates are lower than fixed rates, you can increase your variable payments to match a 5-year fixed payment. That whittles down principal faster and cuts your interest paid (not interest rate) by perhaps three-quarters of one percent over five years.
Timing is Futile: Even if you had the ability to predict rates one year ahead of time, it wouldn’t help. The problem is, knowing short-term rates doesn’t help you predict long-term rates, and the majority of mortgages are 3+ years. In the past, short-term rates have often surged, only to fall back withing 18-24 months. People who lock in on the way up frequently lost out as a result.
“Fixed Rates:” Why Go with Fixed?
Research Bias: Historical research clearly establishes that variable rates have had an edge but past performance foes not foretell the future. Rates have fallen steadily since 1981. By definition, variable mortgages can’t help but outperform what kind of trend.
Cheap Insurance: The difference between today’s variable rates (prime – 0.45% on the street) and good fixed rates (e.g., 2.99% for a 5-year) is quite close. That :safety premium” is the equivalent of less than two Bank of Canada rate hikes. Knowing that you won’t get skewered by escalating rates is worth something.
Economic Lows: It’s somewhat debatable, but one could assume that we’re somewhere near the bottom of an economic cycle. If so, rates will ascend as the economy makes a comeback.
About Dan Heon
Dan Heon is the owner and broker of Mortgage Centre / Canadian Mortgage Team Alberta. He has many clients all across Canada that rely on his 18 years of real estate investing and his 13 years of mortgage broker work specializing in real estate investors. In 2010 Dan was ranked 16th in Canada out of over 20000 licensed mortgage professionals according to CMP magazine. Dan’s motto is, “Plan your finance… then finance your Plan!” According to Dan he gets paid by the Banks to help make people millionaires! Visit www.DanHeon.com