Analyzing Variable & Fixed Mortgage Costs

Fixed-or-Variable-Mortgage_thumb[3] Getting the absolute, unequivocal, undisputed rock-bottom best rate creates sheer pleasure for some.

Choosing the best term is usually secondary.

Anyone who understands an amortization table, however, will tell you, without hesitation, that these priorities should be completely reversed.

“Beating the system” and squeezing that extra 0.10% of blood from the lender’s stone is dandy. But it's a Pyrrhic victory if choosing the wrong term costs you 1/2 point.

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  1. First let me say that this is one of the most helpful articles I have found on this topic. The page showing the cost difference of a variable mortgage confirmed my own instincts. I just never had a way to calculate it on my own.
    Secondly, it is truly a shame that the government has set the hurdle so high for variable mortgages. I think it is overkill to insist that everyone meet the payments of a posted 5 year fixed mortgage. Thanks to a few bureaucrats, large numbers of young families will now miss out on the benefits of a variable rate.

  2. Still not a SAFE bet with Variable rate. Or is it? Offered a 4.5% 5 year fixed rate or will I stick with my 2.05% variable rate?

  3. Hi Melanie,
    Thanks for the question. Are you working with a mortgage planner or bank advisor? If so, they should be able to run the numbers for you from a purely mathematical standpoint.
    Then there are financial and risk factors to consider. Unfortunately it’s a really complex question to answer here in a few sentences!
    Cheers,
    Rob

  4. Hi Melanie,
    I would definitely suggest using an Independent Mortgage Broker. for one, those rates you listed are really high, even for right now.
    Secondly, a Good Mortgage Broker will usually take the time to see not just the hard numbers, but whether your situation is right for a variable. I usually ask my clients, if your mortgage payment went up by a few hundred dollars one month, would that be ok with you?
    Another thing to look at is amortization to give you flexibility on payments to save you interest and pay more principal.
    Give an INDEPENDENT Mortgage Broker a call or send me a quick email. I’d be happy to help.

  5. I think too many people quote Milevsky’s research without understanding it. I have heard him say on multiple occassions that this time could be different.
    If any time in history would be different it would be now. The Bank of Canada rate won’t get lower than .25% so there is only one way to go from here!

  6. I agree with Jim. A person I know just bought a house and took out a $600,000+ mortgage at 1.9% in the Edmonton area. They (and a lot of other people) would not have qualified under the new rules that go into effect today (i.e., must qualify at the 5 year fixed rate).
    This person also keeps talking about how great the variable rate is and how he expects a great return on his “investment” as property values continue to climb.
    Sounds like disaster in the making to me. For the sake of everyone, I hope that there are far fewer of these kinds of people out there than I suspect.

  7. Perhaps, but the historically low BoC rate isn’t the only variable in the equation. As was pointed out earlier in the month by Rob, the spread between fixed and variable rates is *very* wide at the moment.
    Few people disagree that prime is going to rise, and soon, but there is still a lot of room for prime to increase before people will end up paying more on a variable product. In my own situation, for instance, prime will have to rise over 3.25 percentage points before I’d be paying the going fixed rate…
    There’s an extremely high degree of uncertainty right now. All you can do is take the information on offer and make your best guess, but it probably wouldn’t be the worst thing to make conservative estimates at this point.
    Al R

  8. Ultimately it’s all about the risk premium. Is the future value of $2,000 in realized savings worth the risk of floating the rate as opposed to locking it today? It’s no better than trying to time the financial markets.

  9. My last comment on this…
    It seems that the comparison drawn in the example table won’t apply to some people. For example, about a month ago I qualified for a 1.9% variable (a rate higher than the one used in the example) and a 3.8% fixed (a rate lower than the one used in the example).
    I don’t know if I will actually buy a house, but I did lock in the fixed rate which is good for another 90 days.

  10. I agree with Lior. All this is, is an example of risk premium. Going with fixed is like paying insurance… it’s all about your risk tolerance.
    For me, I recently converted my variable to fixed because I compared the best case scenario (double-dip recession, interest rates stay low), an average case (outlined here), and worst case scenario (variable prime going up to 6-8% within 5 yrs). And to me, the average case saved me only a few thousand dollars. To me, that’s worth the insurance.
    Also, in my opinion if you’re going to go variable, you’re betting that the prime won’t go up that much after 2 yrs. If that’s the case, I think it would be worth looking at a 3 yr variable would be the best rate to look at as you’ll probably be able to renew with a better variable rate after your term is finished.

  11. Rob:
    I think your logic isn’t telling the whole story as it does not cover the entire 5 year period only 18 months. It would be interesting to see if that was extended how fast the approx. $2000.00 differance would evaporate. A few weeks back one could also lock in at better fixed rates then what you have illustrated as well.

  12. I called and got an offer to renew a mortgage early and will go from 3.05 variable to 1.85 on a 60 mth variable mortgage and its -4 below prime. I have to pay 700.00 prepayment charge to break the mortgage before the maturity date of the mortgage.

  13. Hi TSP,
    Thanks for the note. Are you refering to the rate forecast only extending 18 months?
    If so, as noted, it’s really impossible to predict rates beyond that. (Heck, even 6 months out is murky.)
    Rates after December 2011 could go up, down, or flat–but the expected value is flat given the 50/50 up/down probability.
    Moreover, Dec 2011 is the furthest out that any credible forecasts go at the moment.
    While the analysis is hypothetical, it nonetheless demonstrates the potential cost savings for those willing to take a risk and float. That was the primary goal here. Again, variable rates are a bad choice for some, and quite suitable for others.
    Regarding rates, the analysis is meant to reflect current market rates. Your rates may differ, which is why we suggest folks speak with a mortgage advisor to perform the analysis with applicable numbers.
    Hope this helps clarify.
    Cheers for now,
    Rob

  14. Hi James, I’m totally with you on the insurance point. It’s just important folks know what that insurance potentially costs before they make a decision. As you know, the “price” of this insurance has soared in the last few weeks. Cheers, – Rob

  15. Hi Lior,
    Thanks for the post. You’re in the business so you know the research and probably the historical cyclical tendencies of interest rates as well. Based on those factors, client-specific cash flow & pain thresholds, and the best available forecasts, it is possible to approximate the risk/reward of a variable-rate mortgage. Armed with that data, clients can then make a more informed decision.
    Regarding market timing, no one knows how high rates will go, and they never do. Yet we as mortgage professionals still recommend variable-rate mortgages when appropriate. Why? Because we know that the data supports them in the right circumstances. No market timing needed!
    Cheers,
    Rob

  16. I am sticking with variable and have increased my bi-weekly mortgage payments an additional $100 to pay down faster and to cover any huge jumps in prime.

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