A few years ago when I was buying my first home, I was sure I’d be selecting a fixed mortgage rate. I’m the type of person who enjoys the security of knowing what my payments will be each month, and didn’t like the idea of a risky mortgage rate that could increase after buying my home. Then I did some reading, spoke to a few people, and decided on a variable rate mortgage, which I’ve never looked back on. So what changed my opinion? Well first, let’s look at the definition for both just to make sure we’re clear.
What is a fixed mortgage rate?
A fixed-rate mortgage means that the interest rate of the mortgage will remain the same until the mortgage comes up for renewal. Therefore there are no surprises. You know what your mortgage payments and interest rate will be throughout the entire term.
What is a variable mortgage rate?
A variable-rate mortgage means that the interest rate of the mortgage will fluctuate throughout the term. The mortgage rate is set at the prime rate, plus or minus a certain percentage. The prime rate is the interest rate on loans that the banks are currently offering to their best customers and corporations. So if you obtain a variable mortgage rate of “prime -0.25%” this means that your mortgage rate will always be whatever the lender’s current prime rate is minus 0.25%. As the prime rate fluctuates over the term, the interest rate on your mortgage will fluctuate too.
Should I get a variable mortgage rate or fixed mortgage rate?
Now, while I personally favour variable rate mortgages when buying a home, I’m not saying that this option is right for everyone. If you’re the type that has difficulty adjusting your monthly budget when expenses increase, then the potential increases in your mortgage payments with a variable rate may cause you some undue hardship. In this case, it may be best to select a fixed-rate mortgage, which will allow you to plan the amount due for your monthly mortgage payments in the long-run.
What is the benefit of a variable mortgage rate?
That being said, the reason why I, and many others choose a variable mortgage rate is because of the potential savings. When lenders offer you a mortgage, usually the variable rate they offer you is lower than the fixed rate. It may only be lower by 0.5% or less, but when you’re multiplying that by the hundreds of thousands of dollars you’re borrowing over a few decades, it adds up. So that sounds great.
But what about when that nice low variable interest rate creeps up and surpasses what could have been your fixed rate? If you follow interest rate trends, you will notice that interest rates (including prime rates) usually don't increase dramatically overnight. In fact, they have remained quite stable in recent years. When they do increase, it is usually very gradual. As one wise mortgage broker said to me, by the time the variable rate increases to that point, you will already have saved so much in interest, it will be worth it.
What if interest rates go up?
So let’s say you select a variable rate mortgage on a five year term, which is usually the longest term a bank will offer nowadays. Chances are that by the time that variable rate surpasses what could have been your fixed rate (if that even happens), you will be in the latter half of your term, and already have saved a lot in interest. Now keep in mind there is no guarantee of where interest rates will go in the future, and how gradually or quickly they will change. However, over three-quarters into my mortgage term thus far, this trend has proven that broker to be correct.
Am I locked into a variable mortgage rate?
Another thing that provided me with a peace of mind was knowing that if the prime interest rate ever did start increasing at an alarming speed, I always had the option of locking into a fixed rate for the remainder of the term. Now keep in mind that the fixed rate you locked into halfway through your term after the rates have increased will probably not be as good as that fixed rate you were offered at the start of your term, and of course it will be a few points higher than the current variable rate. However once again, the money you could save by initially choosing a lower variable rate over a higher fixed rate may be worth this risk, especially considering the recent stable trends in rates. Finally, one more thing worth noting is that most lenders will not actually change your mortgage payments every time there is a slight increase in the interest rate.
They want you to have a steady payment, and know what amount will be due each month. Therefore even with slight changes in the interest rates your mortgage payments will often remain the same. Your monthly payment will usually only increase if there is a significant increase in the interest rate that would cause your mortgage repayment to surpass the initial amortization period (eg. 25 years). Therefore your payments on a variable rate mortgage may not fluctuate as often as you would think.
When it comes to fixed and variable rate mortgages, there really is no right or wrong answer. I’m no expert on mortgages or interest rates, and a decision like this should be thought out carefully and after doing the appropriate research. However I was grateful to have been guided into a variable mortgage instead of letting my sometimes overly-cautious attitudes toward money steer me in a fixed mortgage.
While fixed mortgages do offer security and stability, I thought some light should be shed on what variable mortgages have to offer when buying a home, which in short, is a chance to save some serious dough in the long-run.