Fixed or Variable?

General Tim Hill, MBA 23 Oct

The decision to choose a fixed or variable rate is not always an easy one. It should depend on your tolerance for risk as well as your ability to withstand increases in mortgage payments. You can sometimes expect a financial reward for going with the variable rate, although the precise magnitude will ebb and flow depending on the economic environment.

Fixed rate mortgages often appeal to clients who want stability in their payments, manage a tight monthly budget, or are generally more conservative. For example, young couples with large mortgages relative to their income might be better off opting for the peace of mind that a fixed-rate brings.

A variable rate mortgage often allows the borrower to take advantage of lower rates — the interest rate is calculated on an ongoing basis at a lenders’ prime rate minus a set percentage. For example, if the prime mortgage rate is 3.00%, the holder of a prime minus 0.50% mortgage would pay a 2.50% variable interest rate.

Over the past several years, variable rate mortgage holders have consistently outperformed fixed.  In 2000, prime rate was as high as 7.50%, but has declined pretty steadily and has sat at 3.00% since October 2010. Historically speaking this is incredibly low, so variable rate holders should reasonably expect rates to rise over time … that said, nobody is expecting an increase to 1980s-era rates and the consensus opinion seems to be that 3.00% will hold in the short-to-medium term.

If you do decide to go with variable rate, keep an eye on the financial markets – in general, a stronger economy leads to inflation, which leads to higher interest rates.  As the federal government attempts to manipulate the economy through various policy applications, higher Bond Yields will cause Fixed rates to rise, and increases to the Bank of Canada “overnight lending rate” will cause Prime rate to rise.