Variable-Rate Payments Over Time

Monthly payments on most variable-rate mortgages fluctuate when prime rate goes up or down.  It’s interesting to see how these payments have changed over time.

We created the chart below to show what one’s mortgage payment would have been had they taken out a variable-rate mortgage based on prime—any time in the last 18 years.

The chart goes back to 1991 and assumes a $100,000 mortgage with a 25-year amortization. (The data is linear so payments on a $300,000 mortgage, for example, would be three times higher than those in the chart.)

The blue line shows how monthly payments have changed with prime rate. 

The red line is the average monthly payment over the preceding five years.

Some points of note:

  • Prime rate has dropped 10% since 1991
  • 1991 is a relevant starting date because that’s when the Bank of Canada adopted explicit inflation reduction targets–a turning point in Canadian monetary policy.
  • Since then, there have been three major prime rate cycles (occurrences where rates had a sustained rise of at least 2%)
  • The average increase in prime rate (from trough to peak) was 3.16%
  • After each low (trough) was made, the average rate over the next five years was 1.23% higher.  In other words, if you picked the worst possible time to get a variable-rate mortgage, your rate over the next five years would have averaged just 1.23% more than the rate you received on closing day—far from catastrophic.)
  • The biggest prime-rate increase started in March 1994 when prime rose 4.25% in 12 months. If you had a $100,000 mortgage at prime back then, your monthly payment would have risen from $610 to $877 (a 44% increase).

The chart is a good approximation of payments, but it’s not exact because it doesn’t reflect repayment of principal.  (That would have been too hard to show in a single graph.)  Moreover, the findings here are anecdotal because there aren’t enough samples to draw statistical conclusions.

Nonetheless, it’s clear how the economy and the Bank of Canada have impacted mortgage costs these past two decades.  As we move out of our current recession, it’s not unreasonable to expect rates could rise at least 2-3%, like they have in the past.

The real takeaway here is that rates can, and do, go down after going up.  So, even though variable-rate mortgagors may feel some pain as rates rise for a few years, the pain has been more than tolerable when viewed over historical 5-year spans.

Does this mean you should jump right into a variable and tell your lender where to stick their 5-year fixed? 

No. It doesn’t. 

It’s still critical to choose a term geared to your financial resources and risk tolerance. There’s always the chance that rates exceed historical norms. Moreover, 5-year fixed mortgages at 4.25% may cost less over five years if rates rise over 2.50% and stay there for a while.

But, at least you now have more context to judge whether it’s worth paying an additional 1.70%+ for today’s 5-year fixed mortgages.


Sidebar:  Here’s a longer-term view of prime rate back to 1951. Fortunately, modern monetary policy has greatly reduced the chances of cataclysmic rate increases, like those seen in 1981.

(Source of chart data:  Bank of Canada)

  1. Variable Rate with a fixed payment set at the posted 5-year fixed rate gives you the best of all worlds.
    1) You are protected against rate jumps, because you are already paying a higher monthly payment than your actual rate (currently at RBC: 5.85% FRM vs. 2.85% VRM). In other words, rates would have to go up 300 basis points before you had to change your monthly payment. In the meantime . . .
    2) All of the extra you are paying goes straight onto principle, knocking years off of your mortgage.
    3) If Prime drops, you get even more going straight to principle, knocking decades off of your mortgage.

  2. Cool post CMT.
    I would disagree with the poster above. I think most people either can’t afford payments at posted rates or don’t want them.
    People concerned about a 3% rate increase and “protection” shouldn’t be in a variable. They should be in one of the record low fixed rates that are now available.

  3. Can someone help me understand this?
    If it costs 1.70% more for a five year fixed, that means prime rate would have to rise at least that much for a five year fixed to be cheaper than a variable, right?

  4. @ Mike – To have the same effect over the entirety of the term, it would have to rise by more, because (given a fixed payment), the extra principle you pay off at the start due to the lower variable rate saves you interest up front.
    Rates have certainly risen by more than 1.70 percentage points during previous rate hike cycles, however.
    Al R

  5. If I understand the graph correctly, you are showing a five year rolling average for monthly payments since 1991. Do you have the same information on 5 year fixed mortgages? It would be interesting to see how the two curves diverge.

  6. Hey Rob,
    Can you see if you can get some stats on city property taxes for the big cities like Vancouver, Toronto, Edmonton etc. The trend (taxes going up)I believe is much higher in a slow down. Or at least debt increasing (look at Canada & the US)
    Some cities like Vancouver which are having the Olympics are going dept into dept like Montreal in the 1970’s. This has to be a bigger problem for housing prices than interest rates (currently) how many home owners factor ever higher property taxes vs. interest rates?
    The cities that have have a history of blowing taxes and provinces that download services to the cities make it tough for homeowners and I think this does not get enough discussion.

  7. I would disagree with the poster above. I think most people either can’t afford payments at posted rates or don’t want them.
    People concerned about a 3% rate increase and “protection” shouldn’t be in a variable. They should be in one of the record low fixed rates that are now available.

    If you can’t afford payments at the posted rate, you probably shouldn’t be buying a house . . . If you don’t want to pay posted rates, then by all means go for a discounted fixed rate. But understand that it will almost certainly cost you more money over the course of your mortgage than the strategy outlined above.
    And your claim that people in variable rate mortgages shouldn’t have an eye to protecting their assets is ridiculous. For people who want the cost-saving benefits of VRM and some buffer from rate hikes, this is an ideal strategy.

  8. In fact, I’ll disagree with you — advising people who are worried about rate jumps to go for “one of todays record low mortgages” simply sets them up for a huge potential rate shock in 5 years.
    Advising them to set their payments at a rate higher than they need to (but still within the range that they are able to) would be much more responsible advice. They will pay off their mortgage faster, and they will not be hit with rate shock at renewal time.

  9. Blanket statements about what people can and cannot afford are valueless.
    If people qualify for a CMHC insured mortgage that means they can usually afford the mortgage. Lenders are not in the habit of handing out mortgages to people who can’t afford them. See Canadian arrears data if you need proof.
    Setting payments at the posted rate sounds ideal, but so does setting everyone’s amortization at 15 years. It just doesn’t work, and it is not necessary for the vast majority of Canadian homeowners.

  10. I always go variable. No brainer. 100k @4.5 = 553 per month. 100k@2.75 = 460 per month.
    Since i was gonna have to pay 553 with a 5 year term, I simply stash the difference of 92 each month into a separate savings account.
    Every 6 months I do a royal bank “double up” on my payment.
    Seems simple to me, take the cheapest term, and “pay” the long term anyway.

  11. I agree with Bob. My current variable rate is prime minus 1% (1.5%) but my monthly payments are established at 5.5%. The extra “4%” goes directly on my principal.
    When variable rates will increase, my payments will stay the same.
    No brainer to me!

  12. First posters comments (bob) are one of the smartest comments I have heard. My sister-in-law was telling me recently that she and her husband were so happy to get into a new 5 year fixed at 4.4% last year because their payments dropped so much. I was shocked. I simply cannot understand why people do not take advantage of these all time low rates by paying off extra principal. All they need to do is keep paying what they were before all these rate cuts and they are saving huge and at the same time protecting themselves from any rate increases.
    I too am in a prime minus x vrm and I have continued to pay the same amount as I was paying when I was locked in at 5.1%. Like everyone has said previously…no brainer.

  13. Although the strategy outlined by bob in the first post is clearly the most cautious approach, it is not for everyone. For example, if you are young and already/still have a decent amount of equity in your home, the lower monthly payments on a variable may be an opportunity to make some real investments (the house you live in isn’t really an investment.)
    With an interest rate under 2% (on a variable obtained before the credit crunch), even your after tax return on accelerated repayments is limited.
    I agree with bob’s later comment though, if you can’t afford the higher payments at all, then you have to be careful. As with everything else, you have to make sure you can afford your purchase!

  14. Problem is not every lender is willing to do fixed payments with a VRM. We were fortunate that Maple Trust did, so our payments haven’t changed since we set them when the rate was around 5.1% (now it’s 1.35%). When Scotiabank took over Maple Trust, we were told that they didn’t allow for fixed payments, and our payments would now float with the interest rate. There are ways of getting around the restriction, but they’re not ideal.

  15. I have the same question as “C” for a mortgage newbie such as myself.
    Also for the strategy that ‘Bob’ shares above wouldn’t this be only effective if prime rise in the next few years rises slowly? Cause if rates spiked then the amount put toward your pincipal would obviously decrease. Would be cool to try and plot this based on the data that Rob shared.
    Outside of a fixed payment and rate isn’t one of the benefits of a 5yr fix knowing exactly how much principal you will be able to pay off at the end of your term (factoring in planned lump sum/extra payments)?

  16. Setting payments at a higher rate sounds good in theory but most people don’t want their free cash flow tied up in mortgage payments.
    Payments at 5.85% would be $635
    Payments at 2.65% would be $456
    That is a 39% higher payment per $100k and I doubt many people would go for that.

  17. Reading the above comments give me a flashback to 2005, there was a US mortgage blog where posters were arguing back and forth over the merits of ARMS and how most people who were acquiring them were really maxing out.
    Of course we now no how it all turned out, i know i know its different here which would be true only if it wasn’t.

  18. It’s not everyone’s long-term financial goal to pay off their mortgage at the earliest opportunity. In fact, many people in recent years never intend to ever fully pay off their mortgage and only desire the lowest possible monthly payments.
    We in the FI industry call it within inside circles, people on the “Forever, Ever and Ever Plan” Almost everyone knows a friend, neighbour or family member on the “Forever Plan”! Simply they are people always spending beyond their means and then increasing the borrowing against their appreciating assets to finance it.
    Making higher than the minimum payments on your mortgage is a great and simple forced savings method but not necessarily the best return on your money and definately does not accomplish diversifying your asset base. That’s a no-brainer!

  19. Making higher than the minimum payments on your mortgage is a great and simple forced savings method but not necessarily the best return on your money and definately does not accomplish diversifying your asset base. That’s a no-brainer!
    Very true. But:
    1) The interest savings are a guaranteed return. Currently 1-year GICs, which are probably a decent comparable to a VRM given the time span of interest rate changes, provide you a worse return (1.25% currently at ING) than paying off your mortgage — especially once taxes are included. You could probably make more on stocks, ETFs, mutual funds, etc., but of course you could also lose all of that money like many (most?) people have done over the last 2 years . . . As always, it depends on your risk tolerance.
    2) While it seems popular these days to make the argument that your home shouldn’t be considered an investment (see Chris’s comment above), this seems a bit too pessimistic to me. The equity you gain on your house is — more than likely — not an irrelevant investment. But, again, risk tolerance should determine whether or not your house (and the interest savings of accelerated payments) constitute an “investment” or not.

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