Variable or Fixed Term

More than just which property to decide on

As mortgage professionals we are repeatedly asked by our clients what term they should select when taking out a mortgage. While there is no right or wrong answer a few thoughts on the matter make help clarify the situation and enable you to make a more informed decision.

Historical data suggests that variable rate mortgages have worked out to be the most beneficial for the consumer. A recent survey by one of the major chartered banks indicates that over the last 40 years or so the person selecting the variable rate product was better off 83% of the time. A very compelling reason to go with variable over fixed.

However, one should look at the current situation before rushing out and signing up for a variable rate product. Most experts and economists are predicting that interest rates have nowhere to go but up once the economy recovers. When this may happen is open to interpretation. The crisis in Europe with the sovereign debt problem has been dragging on for months with no agreement in site by the players involved and none likely in the immediate future. Nobody wants to bite the bullet on the issue, so round and round we go with the experts on the outside offering various remedies but nobody willing to swallow the bitter medicine. What does that mean to you back in Canada? For the moment low interest rates as Europe edges toward a very severe recession which would definitely have a negative impact on the world economy. Increasing rates at this time would only exacerbate the problem. The situation will be resolved one way or another and the world economy will recover. The Great Depression of the 1930's eventually ended and so will this recession. Knowing how long it will take for the recovery to begin is the problem.

Having said all the that, one should look at the actual rates. As we speak today you can select a five year fixed term mortgage at 3.14%*. Compare this to the variable rate product currently advertised at 2.85%*. The spread between the two is very close and the fixed 5 year term now warrants consideration as the better alternative; the other 17% of the time may be here. For the sake of such a small spread is it worth it to you to be constantly on the edge of your chair fearing each and every Bank of Canada meeting? Rates go up slightly and guess what, you lose.

We don't know where interest rates will be over the next five years but you should calculate whether you could absorb an increase. If you are on a tight budget the better alternative may be the fixed rate option.

Another consideration. Several economists believe the Canadian housing market is in for a correction as the market is overheated and a bubble has developed. With a short term product such as a one or two year term (whose rates are sometimes lower than the variable ) the bubble could break just before renewal. If the balance outstanding on the mortgage exceeds the appraised or market value of the house on renewal the lender could refuse to renew or make you pay down the mortgage to reflect the proper LTV ratio. Neither picture is a pleasant option. If you were on a 5 year fixed term you do not have to worry for at least five years.

Do the math, look at several options and ensure your comfort level before signing on the dotted line. Give us a call, we can help you crunch the numbers and ensure you are making an informed decision.