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Fixed or Variable? Updated Perspectives

Moshe-Milevsky When deciding between a fixed or variable rate, people often turn to the most quoted research on the topic: that done by Dr. Moshe Milevsky.

Dr. Milevsky found that 77%-90% of the time people pay less interest over the long-run by choosing a variable-rate mortgage.  (See CMT’s April 2008 story entitled Fixed or Variable Mortgages – Research Update)

But today is a new day.  A lot of people think things are “different this time.”  So we took the opportunity to speak with Dr. Milevsky for a current view of his previous findings.  It was a highly informative and reinforcing discussion that we’d like to share here.


On How Today’s Economy and Market Impacts His Research

  • "An environment like we're seeing today brings into question any type of historical study," says Dr. Milevsky.
  • He notes that several things have changed since his original report in 2001:
    • The original study used prime rate as the proxy for variable rates. However, “You cannot get prime today,” he says. “The premium (of fixed rates over variable rates) has disappeared. That makes a difference.” 
    • Naturally, as the differential between fixed and variable rates decreases, the odds of a borrower doing better in a fixed rate increases.
    • Falling home prices, reduced availability of credit, and employment instability also add material risks to the equation.  Today’s mortgagors must consider these added risks carefully when evaluating a variable rate.  Dr. Milevsky believes this applies especially to those with small down payments, like 5%.

On The Effect of Historically Low Interest Rates

  • A lot of people think rates can’t go much lower. However, Dr. Milevsky suggests considering this as a possibility nonetheless.  "Look,” he says. “I never would have said this three years ago, but prime is at 3%. Why can't it go to 1%?"
  • Realistically, however, the odds of rates falling much further have declined, he says.
  • On the other hand, Dr. Milevsky has never strayed from one central tenet.  "It’s not about speculating where interest rates are going,” he believes.  “It’s about risk management.”
  • “In the original study we never said that floating your mortgage is better 100% of the time." There have been “periods of inversion” where fixed rates were actually lower than variable rates.  Indeed, the original study found that 10-12% of the time it pays to be in a fixed rate, “and this might be one of them" he says.
  • Notwithstanding the above, Dr. Milevsky still maintains that "over long periods of time the odds favor a variable.”

On: Comparing Short and Long Mortgage Terms

  • When comparing a short term (like a 1-year or 3-year) to a longer term (like a 5-year), Dr. Milevsky says calculating the “break-even rate” provides a helpful metric.
  • The break-even rate is the hypothetical interest rate whereby a borrower will be “indifferent” between a shorter and a longer mortgage term.
  • For example, if one is comparing a 3-year mortgage to a 5-year mortgage, Dr. Milevsky asks: “What is the number in 3 years that will make me regret not having gone with the 5 year?"
  • To put it another way, think of two individuals:
    • One locking into a 5-year fixed
    • One locking into a 3-year fixed, followed by a 2-year fixed.

You can create an amortization schedule for each scenario, he says, and then solve for the interest rate that would make the total interest paid equivalent in each case.  That is the “break-even rate.”  If you feel interest rates will be above the break-even rate in three years, then it may make sense to consider the 5-year fixed instead.

On What to Look for in a Mortgage Today

  • “As we’ve said before, people should strongly consider mortgages that are part fixed and part floating,” says Dr. Milevsky. Such mortgages are called hybrids, and they’re designed to offer interest-rate diversification. Diversification benefits borrowers just like it benefits investors who buy portfolios of stocks.
  • Also worth considering are “all-in-one” accounts, which roll your mortgage and other debts into one low-rate loan.  Dr. Milevsky says the benefits of these accounts “compound over time” and are “larger than you’d expect.” He did a study in 2005 that supports this. Here is the link.
  • The market’s current 3-year fixed-rate promotions might also have merit.  “If someone is looking at getting a 3-year fixed there is no way I can say to someone don't lock in for 3 years, especially if they have a high ratio mortgage.” With a rate of 3.75%, 3-year fixed rates are actually below most variable-rate mortgages.
  • In general, “if you have a lot of assets, I would go with the lowest possible rate,” he says. That’s true whether it’s a fixed rate or a variable rate.
  • However, folks with a small amount of equity (like many first-time homebuyers), or those with low or unstable income, should focus on “locking in at a low fixed rate.”


Dr. Milevsky is an Associate Professor of Finance at York University’s Schulich School of Business, Executive Director of The Individual Finance and Insurance Decisions Centre, and author of the mortgage industry’s preeminent research on fixed and variable interest rates.