Fixed vs. variable mortgages: How to choose

The good news in the housing market these days isn’t just low interest rates.

Experts say that whether you choose a variable rate mortgage or a fixed rate for a set period of time, the difference over the long run is likely to be minimal.

Rates have never been this low so Canadians are increasingly looking for advice when it comes to mortgages. The question of fixed versus variable takes on greater importance when you consider where rates are and the possibility that rates will start to increase towards the end of this year.

Experts typically say that a fixed-rate might bring more peace of mind to first-time home owners, and that those who are further into their mortgage payments may like to try a variable rate to save some money.

But that may not be right for everyone.

There is really no generic answer,

What’s right for me may not be right for you or someone else because we’re all at different stages in terms of financial planning and lifestyle.

The big advantage of fixed rate mortgages is that they offer a high level of stability. When you lock in a mortgage at a fixed rate, you’re locking in for the term of your mortgage so you will know, for each monthly mortgage payment, exactly how much is going to the interest and how much is going to the principal.

You’ll know at the end of your term how much of your amortization you’ve paid off. The downside is that you can’t take advantage of lower interest rates. If rates do drop, you won’t have the ability to have more of your payment go towards the principle and less to interest,

With a variable rate mortgage, your monthly payments don’t change. What may fluctuate is your interest rate. That means when rates go down, an increased amount of your payment will actually go to your principal, and less to interest. That means when rates go down, you’re paying off your mortgage faster.

But when interest rates increase, so does the portion of your payment that goes to interest. With less going to cover the principal, it’s possible that your amortization period could be extended.

Research by Canadian economic experts shows that variable rate mortgages hold more benefits to consumers the vast majority of the time.

A study of mortgage rate data from 1950 to 2007 and found that choosing a variable rate mortgage would have saved Canadians $20,000 in interest payments over 15 years, based on a $100,000 mortgage. also found that Canadians would have been better off with a variable rate mortgage compared to a five-year fixed rate 89 per cent of the time.

The question is whether this other 11 per cent of the time when it is advantageous, is right now.

This is one of the few examples of times when it really doesn’t make much of a difference. If you take variable and I take fixed now and we meet five years from now, you would probably be able to see no much of difference.That’s largely because interest rates are so low right now. Economists are expecting rates to increase by about half a percentage point, & with further rate hikes to come in 2011.

Right now, variable rate mortgages tend to be about 1.75 percentage points cheaper than fixed rates. But interest rates will probably rise by more than that overall in the next couple of years.

This will probably take variable rates, more or less to where fixed rates are now, maybe a bit higher. If you do the math, you would find the difference would not be very significant,

If you’re looking for peace of mind, he added, take the fixed rate.

If you have a large mortgage vis-à-vis your income, I would go fixed and just relax about it. Learn the market, pay as much equity as possible but go fixed because you don’t want the volatility. However, if you have been in the mortgage for a while and your mortgage is not as large relative to your income, pay with the variable and you will do better over five years from now but not significantly.

Many banks have an array of mortgage products that combine the fixed and variable rates mortgages. These typically allow homeowners to combine the security of the fixed rates with the ability to take advantage of any interest rate declines.

But experts say that even if a variable rate mortgage could save you money in the long run, you still need to think about the risk.

If a fluctuating interest rate is going to keep you up at night because you’re not sure how much is going to principle and interest, then maybe a variable rate mortgage is not right for you.

It’s also important to consider your stage of life. If you’re counting on having your mortgage paid off in five years because you want to retire, then the possibility of your amortization period being extended probably isn’t for you.

Don’t forget to take your other debt obligations and savings goals into account.

For some people locking into a payment actually gives them flexibility to working to other savings goals or paying other debts.

It’s very tempting to look at low rates today but we encourage people to look beyond where rates are today and consider what mortgage is right for them in the medium and long term.

Call me direct 647.267.6338 for your choice of mortgage or visit me @ www.torontomortgagetrends.com