Time to think Variable?
June 13 2018 Posted by Henry Wood
It may seem crazy to even think about a variable rate mortgage in a time when prime rates are on the rise. The prime rate has increased 3 times within the last year and the Bank of Canada has hinted at another rate increase in July. However bear with me and I will give you a couple reasons why it is worth considering.
First of all let's look at the potential interest rate savings in comparison with the current 5 year fixed rates. Currently 5 year fixed rates are hovering around 3.5%, (some a bit higher, some a bit lower depending on the lender and the specific transaction). Current variable specials are as low as 2.45%, a full percentage point lower than the fixed option.
Generally the Bank of Canada increases prime by .25% so even if they raise it 4 more times you would still be ahead by choosing variable. If they do raise it 4 more times it will be gradual, let's assume over the next two years. If that's the case then you've already been saving interest for those first 2 years, so they would have to raise it another 4 times over the following 2 years before you've caught up to where you would have been with the fixed option. I think we can all agree the chances of them raising prime 8 times in the next 4 years are very slim.
The second reason that variable rate mortgages are worth considering is flexibility. On average around 80% of mortgage holders end up breaking their mortgage early and paying a penalty. On a fixed rate mortgage the penalty is based on the higher of 3 months interest, and what's called the interest rate differential. Particularly with the big banks, this interest rate differential penalty can be quite costly, sometimes over $10,000.
On the variable rate mortgage the penalty is simply based on 3 months interest. On a $250,000 mortgage at these rates that would work out to around $1500. So if you're one of those 80% of mortgage holders that for one reason or another ends up needing to break their mortgage, you could be saving thousands on the penalty!
Having said this, variable rate mortgages are still not for everyone. If the thought of your mortgage rate and payment rising makes you uncomfortable to the point where you'll be losing sleep at night, then stick with a fixed rate and enjoy the peace of mind of know nothing will change over the next 5 years.