It’s the age-old question that every mortgage professional will hear many times in their career. With the exception of the last year or so when fixed rates were at an all time low, I have always preferred variable rate terms over fixed. And given the recent significant increases in the fixed term rates I am again 100% back to preferring the variable rate terms…For the right borrower. I personally like to have a detailed discussion with borrowers about finances, budget and long term goals before a recommendation is made. As a borrower, you can expect your mortgage professional to educate you on the options available to you at the time, however, ultimately it is up to you to decide which mortgage term and interest rate suit your needs best as you are the ones who will be making the payments. It is my suggestion that your decision not be based on interest rate alone as there are many any other features and benefits that come with a new mortgage. The lowest rate is not everything as most people will most likely be renewing their mortgage a number of times over the life of their mortgage and not only will rates change, so will your lives. Do always ensure your mortgage is affordable when, not if interest rates rise.
Affordability is not just dictated by your monthly payment, it is also affected by your pre-payment privileges and payout penalties. If you can implement the right strategy, you can pay off your mortgage sooner and protect yourself and your wallet from the potential stress that accompanies higher interest rates. Now that the 5-year fixed rate has gone up by a minimum of 0.50% with the majority of lenders, variable rates are stepping back into the spotlight. Below I’ll talk about a simple effective strategy you can use to pay down your mortgage at a faster rate.
With a fixed rate term, you get a fixed payment and a fixed interest rate for the length of the term you choose. With a variable rate term you receive a fixed discount off prime rate. That discount is what dictates the difference between variable rates, for example; if prime rate is 3%, prime less 0.40% would equal 2.60%, so on and so forth. How mortgage payments work is the discount remains the same, however, if prime rate changes so does your mortgage payment. The appeal of the fixed rate term is that it offers payment certainty, whereas a variable rate term is perceived to be a bit higher risk as your payments could fluctuate. Though more often than not, in the past, the variable rate term has seen interest savings over its fixed rate counterpart. Utilizing your pre-payment privileges during your variable rate term can further increase those interest savings.
Best 5-year variable rate available right now is prime less 0.40%, prime rate is currently 3% resulting in a net rate of 2.60%. The 5-year fixed rate is right around 3.49%. Let’s compare the two, apples to apples. A $250,000 mortgage balance would have a fixed payment of $1,246 per month based on a 25-year amortization and a 5-year fixed rate of 3.49%. If you chose a variable rate term instead, the same mortgage would have monthly payments of $1,132 based on today’s best rate of 2.60%. That is a savings of $114 per month, or almost $1400 a year, as long as prime rate doesn’t change. In addition to the monthly payment savings, you’re also paying less interest over the life of your mortgage.
You can further enhance the automatic savings a variable rate term offers by utilizing your pre-payment privileges to pay down your mortgage balance even quicker simply by taking a prime less 0.40% variable rate mortgage at $1,132 per month and increase your payments like you took a fixed rate at $1,246 a month. To implement this program with ease, ensure your lender will allow you to set up a payment increase once and have it run on a continuing basis every regular payment date. This way you don’t have to call or email to set up the pre-payment every time your regular payment is scheduled.
The above strategy also acts as a buffer against rising interest rates at renewal time. The idea being it results in a lower mortgage balance at renewal leading to a reduced payment even if interest rates are higher. But if you’re really worried about rising interest rates, take a fixed rate term and avoid losing sleep. Just be aware that the payment certainty could result in higher interest costs.
The case for fixed rates is they offer payment stability and a lower qualifying rate. When you are allowed to qualify at a lower rate, your maximum approved mortgage amount is usually higher. That can be appealing if you’re determined to maximize your borrowing power. The good news is you can maximize affordability by taking a fixed term upfront and then switch to a variable rate at renewal time. If you are able to put some extra funds towards your mortgage principal during your fixed term, you can still reap the benefits of interest savings and a lower mortgage balance come renewal or refinance time.
If you ask me today, should I take a variable or a fixed rate, I will say a variable rate. And again, I do not recommend a variable rate for every borrower as variable rate terms have to be monitored and managed properly. Talk to your favourite mortgage professional about a custom mortgage repayment strategy that you can easily implement to ensure your mortgage is a “home sweet home” experience rather than a financing fiasco.
CHECK OUT OUR OTHER BLOG POSTS ON FIXED VS. VARIABLE RATES HERE!