Variable vs. Fixed – the debate continues…still not one size fits all.

Variable Rate Mortgages vs. Fixed Rate Mortgages – the debate continues… It’s still not one size fits all.

Variable rate mortgages vs. fixed rate mortgages…the age-old question asked to almost every single mortgage broker out there on a daily basis by their clients. Some recommend fixed and some recommend variable. You’ll likely never get the same exact answer out of two people, and for a very good reason.

Variable rate mortgages possess their own advantages and disadvantages just the same as fixed rate mortgages do. What it really comes down to is your own unique situation. I might recommend a variable rate mortgage to one client and a fixed rate to the next depending on their circumstances. I’ll elaborate 🙂

Until the new mortgage rule changes, borrowers actually had more choice in terms of the amount for the mortgage they got, or the mortgage product they chose.

Variable carries more risk (for some)!

Variable rate mortgages can be advantageous (cheaper in some cases) IF you are risk tolerant. By risk tolerant, I mean someone that can handle a fluctuation in payments month to month. For some, homeowners and investors alike, a change in mortgage payment, whether it be 40 dollars or 400 dollars a month, might not be a big deal. But for others, even a small change in payments might be a big challenge. An example of a situation where I might urge someone/clients to take a fixed rate mortgage would be if they were a young growing family on a single income. You could imagine supporting children and making ends meet, in our market where housing prices are quite high, is a challenge in and of itself. Toss in the unpredictability that comes with a variable rate mortgage and you have a recipe for uncertainty which equals stress on the family. In this case, a fixed rate mortgage comes with the certainty of knowing exactly what the payments are for the entire duration of the mortgage term, making it easier to budget monthly expenses.

One main thing to consider should be to avoid a variable rate mortgage based solely on the fact that the payments are initially lower. But what happens when rates rise? Can you withstand a small or significant increase?

And what about the fact that prices are so high in our local market… Many homeowners are basically maxed out on their mortgage (meaning, their mortgage is already at the top of what they qualify for and what they can physically budget for). You don’t want a variable rate mortgage in this situation because it would be far too stressful not knowing if you’ll be able to make your payments month to month.

When you’re assessing your situation whether that be buying a new home (taking out a new mortgage), refinancing or renewing an existing mortgage, you’ll want to take inventory of how much risk you’re willing to take. If the answer is ‘I don’t want any fluctuation’, then you’ll likely want to opt for a fixed rate mortgage.

Now let’s look at the qualification measures for both types of mortgages. Before the new mortgage rule changes, it was actually harder to qualify for variable rate mortgages. Now… believe it or not, it’s actually EASIER to qualify for a variable rate mortgage, which is entirely backwards because variable rate mortgages carry more risk!

More on why I think the government ‘stress test’ intervention was a bad move in another post…

Before I wrap thing up here, we should also look at the PROS of a variable rate mortgage, or adversely, the disadvantages of the fixed. The big one is penalties! If you’re in a variable rate mortgage and you need to break that mortgage for any reason, the penalty is significantly cheaper! When you need to leave a variable rate mortgage, the penalty is only three months’ interest whereas the fixed rate opponent uses what’s called an IRD (Interest Rate Differential). In some cases these penalties are huge! There are of course reasons why it still might make sense to break a fixed rate mortgage and absorb such a penalty, but this will need to be looked at on a case by case basis.

As of today’s date, the variable rate mortgage interest rate is ‘potentially’ cheaper (varies of course!). It’s about a 1% difference in rates right now between the variable and the fixed. Don’t forget however, choosing this type of mortgage based only on that initial lower payment may not be the best choice.

Remember, your mortgage broker is your best friend when you need to look at what option is better for you. We take a completely unbiased look at your situation and the market to help you choose the option that will best benefit you and your loved ones.

I would love to hear your questions about variable vs. fixed – connect with me anytime!

PS – Stay tuned for my next article where I will share with you why I feel the government intervention in the new mortgage rules was uncalled for and is hurting Canadians.

PROS Allows for more flexibility to get out of the mortgage. Usually a smaller penalty, may be advantageous on rate long term. Interest rate stays put so expenses can be managed with a fixed budget. Allows you to split the mortgage into different components which may end up with a more overall attractive rate without having the full risk of a variable mortgage ie. 50% variable, 50% fixed. Usually as a component of the mortgage. It allows for extra security and peace of mind. In case needed for ex. A special assessment. If it’s not used it doesn’t cost anything to have. When in use, payments are interest-only payments, more importantly, it’s advanceable and OPEN. You can pay it off at any time and then re-borrow your own funds. Lowers monthly payments are interest-only, and therefore increase your cash flow.
CONS The rate is a fluctuating rate so as prime fluctuates so will the mortgage rate. With the majority of lenders, this also means an increase in payments. Usually a higher penalty if you have to break the mortgage as they use an IRD. Borrowers pay a premium on the rate to keep the rate as is for the duration of your mortgage. Although it gives you the best of both worlds, the cons of combining it also make it more restricted for you. For this reason, most people choose one or the other. Clients have to be careful not to use their HELOC as a debit card as they would be spending the equity they worked so hard to get. Again with a fluctuating rate based on prime, the cost of borrowing can jump during the time that a balance is carried. Minimum payments are interest-only so if borrowers aren’t contributing more, they never pay off the balance. Interest only payments- never paying down the balance, not building equity,  and not re-advanceable.
IDEAL CANDIDATE Someone who is not over-leveraged, getting a much smaller mortgage than they are approved for, someone who has cash savings to fall back on, and someone who is looking at holding a property short term/ unknown but would like the flexibility of selling it with the lowest penalty (ie. investor). Someone who is getting into a home on the higher end of their budget. Someone who has a lot of fixed expenses, someone who is risk averse because they don’t like or can’t handle an increase in their payments. Someone who is very rate sensitive but still wants to take advantage of the variable on a portion of their mortgage. This person can have the majority of the mortgage set up as fixed with a smaller portion as a variable. Their combined interest rates will be lower than an all fixed, and they would be taking a smaller risk on the fluctuating mortgage. Someone who doesn’t carry debt, and uses their HELOC responsibly. Ie many like to use their HELOCS for low-risk investments such as another real estate, RRSP, etc.

I would recommend a HELOC for anyone who has a lot of equity in their home or is putting a large down payment. This way the homeowner can take advantage of the lower payments but have access to the funds later on if needed.

Someone with fluctuating income, usually in terms of Bonus. This would be good for someone who has the ability to make lump-sum payments but wants to carry a lower monthly cost
NOT SUITABLE FOR Young families already maxed out on their budget, very rate sensitive client, clients with fluctuating incomes (commissioned, sales, part-time). Someone who does not plan on carrying that home/ mortgage for the term. Those that overutilized credit. Using their HELOC on “promising, but risky investments). Someone who wants to pay off their mortgage quickly and pay the least amount of interest. This mortgage is not offered by many lenders so choice is limited.
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