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Fixed vs. Variable

Fixed Rate Mortgage Vs. Variable Rate Mortgage

“Should I go with a Fixed Rate or a Variable Rate?” is an oft-asked question in the

MonsterMortgage.ca office. And like most things in life, Variable Rate Mortgages and

Fixed Rate Mortgages each have their Pros and Cons – so here we will break down

the comparison and hopefully you may draw your own insights into which is best

for you.

What is a Fixed Rate Mortgage?

A Fixed Rate Mortgage is a mortgage of any given term (e.g., 1 year, 3 years, 5 years,

10 years) where the interest rate is set and not subject to change over the

course of your term. After agreeing to a Fixed Rate Mortgage, you’ve in essence

locked in a permanent rate for the rest of your term.

What is a Variable Rate Mortgage?

A Variable Rate Mortgage is a mortgage of any given term (usually 3 years or 5

years) where the interest rate moves in lock-step with your mortgage lender’s

Prime Rate.

When a mortgage institution or lender offers you a Variable Rate Mortgage, they

offer you a rate based off the Prime Rate. For example, your lender may offer you a

rate equal to Prime Rate minus 0.50% or (Prime – 0.5%).

Why is the rate offered to you worded this way? It is because the Prime Rate can

both increase and decrease.

What does it look like when the Prime Rate moves?

Let’s say the Prime Rate is 3% today. A mortgage lender in Canada may offer you a

mortgage of Prime minus 0.25% (Prime – 0.25%). This offer would mean that your

interest rate is actually 2.75% (3% minus 0.25%).

Perhaps one year later, the Bank of Canada announces a change that moves the

Prime Rate to 4%. Your Variable Rate Mortgage will also change too. Your

mortgage would now be 3.75% (4% minus 0.25%) and your mortgage lender

would adjust your mortgage payments to a higher amount to include this new

mortgage rate.

Keep in mind that the Prime Rate can also move down, or even remain flat for

long periods of time. In fact, the Prime Rate has remained at 3% between the period

of October 2010 to March 2014 and pundits expect the Prime Rate to remain at 3%

until 2016.

What influences the Prime Rate to move up and down?

The Prime Rate is largely influenced by the Bank of Canada’s Overnight Lending

Rate. When the Bank of Canada moves the Overnight Lending Rate, you’ll see the

Prime Rate move in the exact same manner.

How often does the Prime Rate move?

The Bank of Canada announces whether it is moving the Overnight Lending Rate

during scheduled announcement dates. Remember, the Overnight Lending Rate is

the key influencer of the Prime Rate – so if you have a Variable Rate Mortgage, these

are the dates to look out for.

The Bank of Canada typically holds 8 of these announcements each year and may

choose to increase, decrease or keep the Overnight Lending Rate at status quo.

What are the Benefits to a Fixed Rate Mortgage?

Your interest rate and your mortgage payments won’t change until it’s time to renew

your mortgage. The security and comfort of knowing your payments won’t change is

valuable to many people. Knowing your monthly mortgage payment also allows you

to confidently plan any budgets you may have in mind.

What are the Benefits to a Variable Rate Mortgage?

The interest rates offered by Variable Rate Mortgages are typically lower than

interest rates available with Fixed Rate Mortgages; however, there is no guarantee

that your rate won’t change.

What if I want to switch my Variable Rate Mortgage into a Fixed Rate Mortgage

during my term?

If you have a Variable Rate Mortgage, many mortgage lenders will allow you to

lock in your Variable Rate Mortgage into a Fixed Rate Mortgage. This is useful in an

environment where the Prime Rate is going up and Variable Rate Mortgages become

more expensive.

In fact, taking a Variable Rate Mortgage at a low interest rate and then “locking in”

when interest rates increase is a commonly used strategy among Variable Rate

Mortgage holders; unfortunately, many Canadian home-owners are unaware of this

option.

WHAT YOUR BANK WON’T TELL YOU ABOUT ‘LOCKING IN’:

If you want to lock in your Variable Rate Mortgage into a fixed rate, here is what you

need to know:

1) Make sure that the bank or lender you have chosen allows its customers the

choice of locking in their Variable Rate Mortgage.

This is an option that you should expect with your Variable Rate Mortgage

– if this option isn’t available to you – consider taking your business to a

mortgage lender who will keep this option open for you.

2) A bank or mortgage lender who uses Posted Rates will use these rates

against you if you decide to lock-in your Variable Rate Mortgage! How?

Let’s say you have a Variable Rate Mortgage with a 5 year Term. After much

deliberation, you decide that you want to lock in your rate – that is to say,

you want to turn your Variable Rate Mortgage into a Fixed Rate Mortgage.

The issue then becomes – what is the new rate you will receive?

If your bank uses Posted Rates (whether online on their website or on a

chart located within their local branch), you’ll typically receive a rate that is

one percent or one and one-half percent off of their inflated posted rate. That

is to say, you won’t be receiving the best rate available when locking in.

(As of this writing, 5 year Fixed Rate Mortgages are available at 3.4% — the

Posted Rates for 5 year Fixed Rate Mortgages are listed at 5.24%)

For example, if you were locking in your mortgage today, you might receive a

rate equal to 3.7% — when rates at 3.4% are readily available.

Well, most people typically want the best rate available; however, you no

longer have leverage from a negotiation standpoint – after all, you can’t go

elsewhere with your mortgage without paying a penalty. At this point, not

even MonsterMortgage.ca can help!

3) Most banks and some mortgage lenders will lock you in but at the rate of

your original term – not the term you have remaining! What does this mean?

Once again, let’s say that you have a Variable Rate Mortgage with a 5 year

term. After 3 years, you decide that you want to lock in your Variable Rate

Mortgage – with two years remaining in your original 5 year term, you figure

that you’ll now be receiving a 2 year mortgage rate. Right? Wrong.

Your bank may choose to lock in at a 5 year mortgage rate; at an interest rate

significantly higher than what is available for 2 year mortgage rates.

Make sure your mortgage professional discusses these clauses and rules with

you before placing you into a Variable Rate Mortgage. There are mortgage

lenders in the Canadian market who do not result to these tactics to pad their

bottom line.

What if I want to switch my Fixed Rate Mortgage into a Variable Rate Mortgage

during my term?

If you have an open Fixed Rate Mortgage, can move into a Variable Rate Mortgage;

however, if you have a closed Fixed Rate Mortgage, you would have to break your

mortgage (and incur mortgage penalty costs) before moving into a Variable Rate

Mortgage.

I’ve learned a lot about Fixed Rate Mortgages and Variable Rate Mortgages,

but which is best?

This is the age-old question that doesn’t always have a clear answer. A 2001 study by a

York University professor (http://www.ifid.ca/pdf_workingpapers/WP2001A.pdf) shows

that from the years 1950 through to the year 2000, a Variable Rate Mortgage in Canada

would have been better for Canadian home-owners 90% of the time when compared to a

fixed rate mortgage.

While it is difficult to argue with the historical results of the Variable Rate Mortgage

when it comes to saving money, the certainty that comes with a Fixed Rate Mortgage

is valuable to many home-owners who want to set their mortgage budget knowing that

movement in Canadian mortgage rates won’t matter to them.

Ultimately, the fixed rate mortgage provides assurance and certainty; however, that

comes at the price of a higher mortgage rate. If you, as a home-owner, are comfortable

with the idea of a variable rate product, whose mortgage rate will shift up and down

according to the prime rate, then a variable rate mortgage is the mortgage product for

you.


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The closing went well today. And we just want to say thank you so much from the bottom of our hearts for all your help and also thank you for being so patient with us. Thanks once again, Joice and Philip – Toronto, ON
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