Should I Choose a Variable Rate Mortgage?

September 10, 2014 | Posted by: Ron Chan

I had a client ask me the other day, “Should I take a variable rate mortgage or a fixed rate mortgage?”

My reply was – “It depends on your tolerance for uncertainty”

Variable rate mortgages are attractive as they seemingly offer really low rates. In most advertisements what you will see is the rate. What is equally important is how is that rate derived which is typically a function of the bank’s prime rate plus/minus a certain percentage. Currently (July 2014) we are seeing posted 5-year variable rate mortgages at 3% (Prime + 0%). For comparison sake, posted 5 year fixed rate ranges from 4.79% (TD) to 4.94% (RBC). Keep in mind that posted rates are what you will find on the bank’s website - what you can actually get will depend on your negotiation skills or if you use the services of a mortgage broker (i.e. Me) but I digress. Note - rates used in this article are for comparison only. So the variable rate looks much better in this example. What are things I have to consider?

When qualifying for a mortgage, anything less than a five-year mortgage rate or if you are doing a high ratio mortgage (i.e. less than 20% down payment) you will have to qualify using the Bank of Canada qualifying rate (currently at 4.79%). This qualifying rate is used to ensure borrowers can handle their payments if rates go up.  Your mortgage payment at this rate is a good number to know, as it will help you decide whether you would be more comfortable with a fixed or variable rate.

For example, a $250,000 mortgage amortized over 25 years at 3% is $1,183.11 vs. $1,424.27 at 4.79%. Could you handle a mortgage payment increase of $241.16 per month if your mortgage rate increased to 4.79%? This can be a scary proposition for some and this is why qualifying rules were introduced in recent years to ensure people don’t get in over their heads with their mortgage. Having said this, in most cases your mortgage payment will be fixed at a certain number for the term of the contract. Any increases or decrease will determine how much of your payment is going to interest and how much is going towards principal. However, if your variable rate goes high enough it could trigger an increase in mortgage payment.

Other Pros and Cons?

PRO - In a stable or decreasing interest rate environment a low variable rate will allow you to pay your mortgage off quicker.

CON - Variable interest rates are unpredictable. So if you are a fan of certainty, a variable rate might be uncomfortable.

If you are thinking of going with a variable rate mortgage here are some things to ask your lender or broker:

  • How often or when could my mortgage payment change? When the rate changes or is it some other trigger?
  • What would my payment look like in certain scenarios i.e. if the rate went up 1% or 2%?
  • How does the length of time it takes to pay off my mortgage get affected with a change in interest rates?
  • Am I given any notice of any changes to my mortgage payment?
  • What are some features that can help protect me from increases in the variable rate…can lock in a rate or convert to a fixed rate mortgage?
  • How is my variable rate determined? Prime minus what? Currently (July 2014), we seen some 5-year variable rates as low as Prime - .70% = 2.30%

As you can see, it’s important for you to understand how a mortgage works and how certain features and benefits can suit your needs. Most of us are driven by rate, it’s equally important to understand what you are getting with that rate.

If this article has triggered other questions you might have about mortgage financing….

As always, you can call me at 204.290.9950 or email me at ronchan@invis.ca to help you with your mortgage needs or questions.

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