FIXED VS VARIABLE?


Bond prices are on the rise and so are fixed rate mortgage rates. The good news is that low variable rates are here to stay for the foreseeable future and historically are the better option.


Here is why we recommend a variable mortgage. Most people break their mortgages before their 5 year term is up (Canadian average is 36 months, according to Internal lender statistics). The prepayment penalty, cost to break a mortgage contract, is much less on a variable mortgage’s 3 months simple interest calculation vs a fixed rate mortgage’s Interest Rate Differential (IRD) calculation. People with a fixed mortgage rate often find themselves paying 4.5-7% of their mortgage value to break a contract! That can be $10-$40,000 depending on the size of the mortgage after 2 years!


Here are more details to chew on:

Fixed:

  • obvious benefit of no change in rates for contract term

  • prepayment penalty calculations are different as Interest Rate Differential comes into play which means it's potentially more expensive to get out of a fixed rate contract. This is important - if you foresee any changes to your mortgage needs in the next 5 years, we recommend you go with a variable rate. We often see clients wanting to break their contract within 2 years, costing them upwards of 10-30K and sometimes even $40K in pre-payment penalty depending on what the interest rates are at the time of prepayment!

Variable:

  • The industry does not anticipate prime increasing until inflation rates increase as the economy recovers. Bank of Canada says this won't be until 2023, but we really don't know this for sure.

  • Lenders will assess the rates every 6 months - so you would only see an increase in payment max twice a year.

  • Some lenders will tolerate an increase in prime and not require an increase in mortgage payment.

  • Worse case scenario, should Prime double (unlikely to 4.90%), your payments only increase by approx 30%.

  • Should rates increase, there are strategies to mitigate the impact - you could set up higher payments with the lender (pay like a fixed rate and payoff your principal sooner)

  • Prepayment penalty is 3 months interest

Where will you be in 2-5 years time? Life changes - people grow and make more money, get married, have more kids, upsize, downsizes, etc. etc. - The bottom line is people’s needs often change. Our recommendation is to stay nimble and flexible with a variable mortgage - it could save you in the long run!

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