I’m often asked by clients, “Should I go with a fixed rate or variable rate”? We need to look at a couple things.
First, what is the spread between the 5 year fixed and the variable rate. Right now, the spread is very small. We have 5 year fixed rates around 2.84% and 5 year variable rates at 2.60%. With only a .24% spread in these two rates, I’m not sure that the spread is large enough to justify taking a variable rate. But before we can say with 100% certainty, we need to look at the second part.
Where are we in the interest rate cycle? We’re currently sitting close to the bottom and there’s no expectation that the variable rate will decrease in the near future. That being the case, the only way to go is up. We don’t know when that will happen but if every time the Bank of Canada increases the prime rate, it does so by .25% (any more is very rare), it only takes one increase and you’ve lost your advantage to going with a variable rate. If it increases twice, you’re losing money on the interest rate.
Chances are, over the next 5 years, there will be some increases in prime, so the odds are against you that you will derive much benefit from a variable rate.
A couple other considersations are whether or not your budget can handle the fluctuations that potentially come with a variable rate, which could then also increase your payments. There are variable rate mortgages that don’t have any change to your payment when rates move, both up or down. The good news is that your budget is static and if rates go down, you pay down the mortgage faster. But, if rates go up, and you don’t increase your payments, you may find that at the end of the term when you go to renew your mortgage, your 25 year mortgage is still at 25 years, or worse. I’ve seen it happen to a client and they were none too happy when they realized this.
The other major consideration is where you are in life. I work with a lot of first-time home buyers. Most of these are younger couples, newly married or living together, and no children. Well, if they are like most first-time home buyers and have a smaller down payment and have bought close to the maximum that they can afford with little savings or cushion to back them up, then going into a variable rate is ill-advised. When rates do move, alogn with the property management fees if any, and their payments increase, this could prove devastating if there is now a new mouth, or two, to feed.
As I have been learning this past year, with children comes a lot of changes to the family budget and very few of those changes are good. Once daycare costs kick in (which is nearly another mortgage payment), a lot of budgets can’t afford to see their housing costs start to escalate a few hundred dollars a month. For this reason, I encourage most young couples to go with a fixed rate at this uncertain time for them financially.
Other families may have the benefit of higher incomes, more equity, and less fluctuation with their budgets. So for those folks, I can certainly see an advantage to a variable rate or short-term strategy as they can weather the ups-and-downs of the interest rate cycle better.
In most circumstances, when asked whether a client should go with a fixed rate or variable rate, I would recommend a fixed rate based on today’s economic information.
If you’d like to review your own situation, please give our office a call and I’d be happy to review the pros and cons of each with you.