Getting Your Feet Wet With A Variable

Female feet in pool water 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.

  1. All mortgages are variable. You can lock for 5 years, one year, or a day, but you cannot lock in for 25 years like the old days. What is called “fixed” nowadays is really a “variable” changing on the fifth year. Can anyone fix a rate for 25 years anymore?
    There is less risk in a variable than a 5yr fixed mortgage, because rates do not rise suddenly within a short period. Your variable savings in the first couple of years easily cover any increased costs in the final few if rates do start to move. A variable gets better if rates stay the same or go down, and EVERYONE must rengotiate on the fifth year anyway.

  2. David,
    I like your approach to mortgages. Although we both know that fixed rate mortgages simply mean that the payment will be fixed during the 5 year period, I believe your analysis may partly explain why variable mortgages tend to outperform fixed rate mortgages. Still, for those who don’t know how to manage their money, fixed rate mortgages make sense since they know exactly how much is needed each month. Give those people a variable rate mortgage and they probably spend the extra money on something else rather than putting it away for when the rates go up. If I were a broker, I might be tempted to partner up with a financial advisor to educate my clients in fiscal responsibility while providing them with the mortgage that generally saves money in the long run.

  3. All mortgages are variable. You can lock for 5 years, one year, or a day, but you cannot lock in for 25 years like the old days. What is called “fixed” nowadays is really a “variable” changing on the fifth year.
    Oh man, give me a break. Talk about a pedantic definition. And not even a very accurate one. It is a “5-year fixed mortgage” or a “10 year fixed mortgage”. Nobody reads “fixed mortgage” to mean “fixed rate until your house is completely paid off”. And, to be strictly accurate, it is a fixed mortgage, because at the end of the 5 years your commitment to that lender is finished. You are not required to extend for another 5-years. You are free to pay off the house with cash, find another lender, sell the joint, or any number of other things. The mortgage no longer exists.
    Another way to “get your feet wet” with a VRM is to look at capped variables.

  4. “Your variable savings in the first couple of years easily cover any increased costs in the final few if rates do start to move.” (Quoted by David Frederick)
    That depends on the pace and degree of rate increases David. If rates rise 350bp in 18 months for example, then what you say is incorrect.

  5. Here’s a better idea.
    Take out a variable @ 1.9 but make your payments @ 4.39% or higher. It’s amazing how fast you can pay off a mortgage doing it that way. Plus it protects you from future rate shocks.
    In my opinion if you’re a financially challenged individual and me thinks there are a lot of them out there. Then you should never take out a mortgage if you can’t afford a rate of a least 5.0%, whether it be variable or fixed.

  6. Fixing a variable mortgage payment at a 4.39% rate doesn’t protect the homeowner if their rate rises above that. That is why people get fixed rates. Some homeowners don’t like payment risk.

  7. I did what DaBull said,
    I have my 1.9 % VR (Prime -0.6) and banked the difference if I was paying fixed 5.5% for the last 1.75 years. The saving over two years is about $13,000. I’ll put it towards my mortgage once I fill comfortable rates will not sky rocket beyond my means and if they do, I’ll dip into the funds to cover the difference. I believe I will still be ahead.

  8. Variable rates are the way to go for most. That has been proven to no end. Too bad the Finance Department thinks it knows best about what kind of mortgages we should have. It is absurd that the qualifying rate has made VRMs so inaccessible to so many.

  9. It seems to me that the faster you are paying off your mortgage the greater the chance that you will come out ahead with a variable. In other words, variable rate are less risky for people with shorter amortizations than longer ones.
    You will be paying a lower rate on the higher amount at the start of the term, then if rates go up you are paying the higher rate on a lower amount.

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