Fixed or Variable – Important Research Update

The debate between fixed or variable rates never dies.  Thousands of mortgage planners and lenders counsel their clients on this decision every day.  In doing so, most of them rely on the landmark research of York University’s Dr. Moshe Milevsky.

Moshe-Milevsky In 2001, Dr. Milevsky made Canada reassess its fixation on fixed-rate mortgages.  He showed with statistical evidence that variable rate-mortgages saved borrowers money 88.6% of the time.  Since then, Dr. Milevsky’s research has been one of the foundations of Canadian mortgage planning.

Now, seven years later, Dr. Milevsky has issued a third and much anticipated update to his 2001 study (here is the previous update).  The results were published recently on, in a story entitled Moving Mortgages.

Among other things, Dr. Milevsky’s newest findings reaffirm his 2001 conclusion that, “over the long run, homeowners really do pay extra for fixed-rate mortgages.”

The following is a list of the other key take-aways from Dr. Milevsky’s latest article:

  • Based on data from 1950 to 2007, the average Canadian could expect to save interest 90.1% of the time by choosing a variable-rate mortgage instead of a fixed.  The average savings was $20,630 over 15 years per $100,000 borrowed.  (The assumptions used are described in the story.)
  • Those who can negotiate big discounts (e.g.  1.5% off posted fixed rates and 0.75% off prime variable rates) save money 77.1% of the time by going variable.
  • Variable mortgages typically let people shave over a year off their amortization.
  • Despite the above, Dr. Milevsky feels there is no “one-size-fits-all solution” to choosing a fixed or variable rate.  He says it depends mainly one’s risk tolerance.
  • The premium of fixed rates over variable rates has declined about 7% in the last seven years
  • Predicting long-term interest rates is virtually impossible.  Dr. Milevsky feels that “even Bank of Canada governor Mark Carney is unlikely to possess” this skill.
  • Milevsky reminds readers that being able to predict short-term interest rates “does not necessarily generate better odds over time.”
  • Here’s a stunner.  Statistically speaking, even people who can accurately predict rate direction one year out cannot beat the performance of variable rates Milevsky says.  He therefore urges homeowners to “avoid the temptation to outguess the Bank of Canada or the billion-dollar bond market.”
  1. Of course, anyone who actually listens to him will probably be bent over their bankers desk. The BoC is cutting rates even though jobs are booming, unemployment is down, participation is up, wages are up, exports bounced back despite our high dollar. That all adds up to inflation coming soon, which will end up to high rates. Hopefully this will wait long enough for me to renew in 4 years, but I doubt it.
    Why couldn’t he research something solid like “If the interest rate you received was less than X% you were better off in a fixed mortgage, if above this level you historically are better off in a variable; past performance can not predict the future”.
    If I start seeing way more ads for variable rate mortgages from banks you can be sure it’s time to lock in your rate. They have only one thing in mind, I’ll let you guess and give you a hint . . . it’s not customer service.

  2. Milevsky’s mortgage research is the best out there. He has shown time and again that regardless of what rates do in 1-2 year periods you are better off in a variable if you can handle the payment risk. Like his story says, this applies even when rates are heavily discounted.

  3. The bank of Canada has no real control over interest rates. Since 80% of our exports go to the U.S. when the U.S. goes into a recession we go into a recession. If U.S. interest rates drop we have to drop rates as well otherwise the Canadian dollar will rise to high killing exports.
    As it stands now Canada has a stronger economy, thats why we haven’t cut rates as aggressively as the U.S. and thats why the Canadian dollar is so high. Canada is curbing inflation by maintaining a higher interest rate/exchange rate relative to the U.S.

  4. Melanie and Robert,
    Great story. I was not aware Moshe did a new study and this update is quite interesting.
    Thank you,

  5. ->Hi Traciatim,
    You might be right about the BoC getting overly zealous on rate cuts. That said, it can be hazardous to second guess folks who have a lot more data about the economy than us!
    As for you research suggestion, I wasn’t sure what you mean. Is X an arbitrary interest rate?
    Just a note of interest. There have been times when Canada has not followed the U.S. into recession. 2001 was a recent example.
    ->Vic and Jen,
    Thank you!

  6. I think what Traciatim means (or at least this is what I think would be useful) is when the other 22.9% of the discounted fixed rate being better than discounted floating rate occurs. If it can be shown that, FOR EXAMPLE, when prime rate is less than 4% there’s 70% chance that fixed rate would be better than floating for the next 3 years, then it would be an exciting result.

  7. gokou3, you hit the nail right on the head, that’s exactly what I mean. Also, with the way the solar cycle (No I’m not a solar cycle nut, but it does play a role) is acting it may delay solar cycle 24 making it less active but long. This will cause less solar output and lower crop yields for the next few years. If that’s really the case this food problem (pronounced, inflation) will be a bigger problem in the near future.
    The only reason we are seeing low inflation numbers allowing the BoC to cut rates is the GST cut. Since final sales price are used and many of the goods in the CPI and CoreCPI are taxable the GST cut has a very large impact on the CPI/CoreCPI percentages. If the government had of cut income taxes like economists wanted the inflation rate would probably be around 2% higher than it is now and the BoC would be forced to keep rates steady or increase rates. They may be forced to in the next while anyway once the inflation numbers start showing higher no matter what the USA is doing. If that’s actually the case, I think we’re in one of the 22% of times that locking in may be good.
    Of course predicting rates over the next 6 months is near impossible and over a 5 year period you’d have to have a time machine, so who knows what’s really going to happen. It would be nice if Dr. Moshe Milevsky knows exactly what the rates were when 22% of the mortgages at fixed rates beat the variables that this information be the primary focus; IE the crossover point being the focus, and not that variables do better most of the time.

  8. Hi Traciatim,
    You mentioned: “I think we’re in one of the 22% of times that locking in may be good.”
    From what we’re hearing from customers and economists, some would disagree with this but many others would agree (I guess that’s what makes a market).
    Of those who agree, most seem to want to go variable for now and then lock in when rates fall. It’s amazing how many people are market timers these days.
    Speaking of market timing, as a long-time equity trader I always get leery when too many people are on one side of a trade. In this case, the majority seems to think rates will keep falling. Yet, now, we’re seeing bond yields start to go up. If the BoC cuts next Tuesday, it therefore wouldn’t be a shocking if it were their last cut for a little while. (Not a prediction, just an observation.)
    On a seperate note, we’re chatting with Dr. Milevsky tomorrow, if you’d like to email or give me a call I will clarify a few points with you and pose your question when we speak to him. My number is (800) 280-2460 x 2.

  9. The only question i would like to have answered is:
    What pattern, if any, was observed to determine when variables are a good choice, fixed are a good choice, and when to lock in rates?

  10. Wow with all this i am already loosing my sleep whether go lock for 5 years or go variable. One bank is offering me 5 year @ 5.3 and other is offering me open variable @ prime -.75. My only concern is will prime go as high as 7.75 for variable open then its obvious its a loss. Also it would be interesting to see how BoC will react one side inflation is rising due to high commodity prices and in adverse if things dont go that well in US our dollar go high and we loose a lot on export so what is BoC going to do then. Any thoughts on this any body.

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