Many people are faced with this decision when purchasing and obtaining a mortgage for their home. Each have their own pros and cons and each are suitable for the right situation and the right borrower.
As of November of 2011 the B20 guidelines made it much more difficult and impossible for some to borrow a variable term mortgage. One of the major rule changes was that in order to qualify for a variable term mortgage or a fixed mortgage of less than 5 years, the borrower needed to get qualified based on the lender’s posted rate, which is currently at 5.34% for many lenders. This is significantly higher than any 1-4 year terms.
This rule automatically leaves many people to fixed mortgages as their only option. Because people would qualify for less with a variable mortgage, it is almost impossible for many first time home buyers to obtain enough funds to close their purchase. However, for many people this is still an option and in the next few paragraphs I will go over the pros and cons of each type of mortgage so you can make the right decision. This decision should be in collaboration with your trusted mortgage professional to choose the right product for you and your situation.
Fixed mortgage rates are controlled by bond yield rate. Different factors such as employment and state of economy affect the bond yield rate. When the bond yield rate goes up, it drives the fixed mortgage rates higher. Variable rates are controlled by similar factors but fluctuate with the prime rate. Prime is set by the Bank of Canada’s overnight lending rate and fluctuates with inflation. With high inflation, prime is higher and prime is lowered to boost economic growth.
Variable mortgages are usually indicated by prime +/- a number. Although prime fluctuates the decided amount whether +/- will be consistent through out your mortgage. IE., if prime is at 3% and you mortgage is prime – 0.3- then your interest rate is 2.7%. If prime climbs to 3.5%, then you would be paying 3.2%.
Variable mortgages are most attractive when there is close to a 100 basis points or 1% difference between fixed and variable mortgages. For example, if the fixed mortgage is 3.7% and the variable is 2.7% it would entice a lot of qualified buyers to get the variable mortgage. The reason for this attraction is under the assumption that by the time the prime rate increase you have paid down more principal of your mortgage because of the lower interest rate.
In 2013, 85% (up from 65%)of the mortgages originated were on fixed terms. There are different reasons such as the B20 rules mentioned earlier but also because the gap between Variable and fixed were very small. People were happy to pay a small difference and lock in the great rate for the term of their mortgage.
Which product is most suitable to you?
Fixed vs. Variable
Fixed mortgages guarantee your payment for the term of your term. There is no need to worry about increasing rates as your payments will not fluctuate and you can plan according to your lifestyle. It is great for young families and for first time home buyers. It is also great for people who do not like taking risk. If there is a change in your employment, or lifestyle, you know exactly what you need to budget for to make your payments. Like anything else in life, we pay a premium for this type of product, as there is no risk with fluctuating payments.
Variable mortgages are great for people who can tolerate more risk. If you have lots of equity in the house and you can still comfortably manage your payments with higher interest rates, a variable mortgage would be a good solution. Another factor is your 5 year plan. If you are deciding to move or upgrade in less than 5 years, a variable mortgage may be more beneficial as breaking a variable mortgage would cost significantly less. Although most lenders allow you to port your mortgage and request additional funds the possibility that you may need to sell your home, refinance it to take out equity or pay for a special levy still exists and with most variable mortgages you would only be paying 3 months interest as a pre payment charge.
Whatever your situation is, it’s unique to you and you should create a budget and consider how much risk you can and are willing to take before you decide on a mortgage product. Your mortgage professional should discuss your long-term plans and make appropriate suggestions on the right mortgage not just the best rate.
Remember, just because someone you know is in a (fixed/ variable) mortgage, it doesn’t make it the right mortgage for you.