Getting Your Feet Wet With A Variable

When the Bank of Canada expressed uncertainty last Tuesday about the sustainability of our economic recovery, it took rate-hike expectations down a notch.

This, coupled with banks’ reluctance to drop fixed rates (despite widened profit spreads), has shifted some interest away from 5-year fixed mortgages. 

When compared to the average 4.39% 5-year fixed rate, variable rates at prime - 0.60% (1.90%) seem alluring.

We’ve written before about how variables can still make sense for the right kind of borrower (see: Variable & Fixed Mortgage Costs). Yet, as rates start an uptrend, some people just aren’t comfortable without a fixed mortgage…and that’s fine. It’s essential to be confident in your term selection because saving money just isn’t worth it when you get an ulcer in the process.

What many forget (or don’t realize) is that you can always get your feet wet with a variable-rate mortgage, without diving in head-first.  It’s done very easily with a hybrid mortgage.

For instance, if you’re leaning heavily towards a fixed rate, you can instead allocate a small percentage to a variable—say 1/3 for example.

On a $200,000 mortgage, that would give you:

• 66.7% ($133,400) in a 5-year fixed at 4.39% [sample bank rate]
• 33.3% ($66,600) in a 5-year variable at 2.00% [sample bank rate]

If you assumed a 2.50 percentage point increase in prime by year-end 2011 (a common economist forecast), this decision could hypothetically save you about $669 over 60 months with only 33% of the risk of going all-variable.*

Some might ask, “Why not go 100% variable if the odds back variables?”  You can ask the same question about stocks and bonds. History has shown that equities handily trounce bonds long-term. But, just because the odds are good doesn’t mean a 100%-equity portfolio is right for everyone.

People have different pain thresholds when it comes to money. For well-qualified borrowers, however, dipping a toe in the variable-rate pool is often better than not getting in at all.

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*  Assumes a 25-year amortization, a 25 BPS rate increase per Bank of Canada meeting [not a prediction, just an assumption], and stable rates once prime reaches 5%. Consult a mortgage professional to determine suitability before acting on this information. Are you cut out for a variable? See: Choosing Between A Fixed And Variable Rate.