Variable, Fixed, Inverted – Michal and Michael Podcast
Michal Sluka – Real estate agent for over 5 years, sold over 300 homes
Michael Huber – Huber Mortgage, 7 years experience
5 Tips for Choosing Fixed vs. Variable
***Besides the fact that the yield curve is inverted and fixed is cheaper than variable***
A mortgage broker’s second most frequently asked question. Should I go with a variable or a fixed rate?
Let’s talk about the historical differences between these two rate options and the people who choose them then delve into why today’s variable vs. fixed rate decision is perhaps easier in today’s inverted yield curve environment.
Five-year mortgage terms in Canada are the most common.
Fixed rate mortgages are most popular, chosen by 66% of mortgage borrowers.
Variable rates are chosen by between 25% and 30%.
Variable Rate Facts
Variable mortgages (or ARM-adjustable rate mortgages) have been less expensive historically. If you’ve had a variable rate mortgage over the past 10-years, you have done well. Variable rates fluctuate with movements in the Bank of Canada’s prime lending rate. This prime rate is affected by Canadian and global economic conditions. When inflation is high, the Bank of Canada will raise the prime rate to counter over-stimulation of the economy. When inflation is low, the prime rate is lowered by the Bank of Canada to stimulate the economy by making borrowing more attractive.
While the variable rate has, over the past 10 years, been lower than the fixed rate, these rates can rise and fall.
If rates rise, less of your payment goes to principal.
If rates fall, more of your payment goes to principal.
Income, lifestyle and risk tolerance should guide rate decision. Risk-averse, growing families tend to pick the stability of a fixed rate. If you think you may have a hard time weathering a rate rise or, more specifically, you don’t think you could weather a 2% increase to the variable rate, maybe variable is not for you. If you are risk averse and your risk tolerance will not allow you to sleep at night with a variable rate, go with a fixed.
Common Variable Rate Strategy
Utilize your mortgage contract pre-payment privileges and increase your variable rate mortgage payment to what the payment would be at the current 5-year fixed rate.
This is good for two reasons: first, you will pay down potentially thousands in principal.
Second, you will condition yourself to pay a higher amount monthly. If variable rates do rise during your mortgage term, you will be prepared to pay the higher amount already and avoid dreaded “rate shock”.
Market Timing Strategy
Some people opt for the variable rate then try to switch to a fixed rate before rates rise. This is tough because even the PhD economists have a hard time predicting when and by how much rates will rise at any given time.
Fixed Rate Facts
Yield on the 5-year Government of Canada bond is the key benchmark for determining the rate for five-year fixed mortgages. Currently, 5-year Government of Canada bonds have dropped and correspondingly, the 5-year fixed mortgage rate has fallen as well.
Why do people choose fixed mortgage rates?
Stability. With fixed rates, you can budget accurately and you always know what your main monthly housing expenses will be. Historically, fixed rate have been more expensive than variables with people choosing to pay the price premium in order to have peace of mind.
Important fixed rate questions
How long do you expect to be in the property?
How does your prospective lender calculate their pre-payment penalty?