The age-old question when thinking about mortgages is whether to take out a fixed mortgage or a variable product. Today, with fixed rates on the rise, it is a question every homeowner — current or prospective — is asking.

Historically, according to different studies — including one recently done by BMO — variable rate mortgages may be preferable because in the long run, they save you money.

For the uninitiated, there are two types of interest rates you can opt for when obtaining a mortgage: fixed or variable. A fixed rate is a interest rate set for a specified period of time (i.e., six months, one year, five years) that is paid on top of the mortgage, whereas a variable rate can fluctuate based on the prime rate set by the Bank of Canada.

Today, the most competitive variable mortgages can be obtained at prime less half-a-percent — and with prime being at 2.25%, this means a low rate of 1.75% to start with. The half-a-percent discount on prime rate would be fixed for the term of mortgage; the prime rate, however, can change any time the Bank of Canada has a meeting.

Mortgage Type	Rate	Payments	Balance at the end of 5 Years	Savings
Variable Prime less 0.40%	1.85% starting rate, assume a 0.25 increase in rate every six months to 4.25%	Start at $833 and increase up to $1,063	$168,069	$7,202
Fixed	4.39%	$1,095	$175,271.37	None

The Bank of Canada can increase the prime rate by 0.25% to 0.5% at each meeting, which means that the prime rate cannot jump up too drastically; rather, any increases will occur gradually. One of the significant benefits of the variable-rate mortgage is the convertibility option, meaning borrowers can convert to the fixed rate at any time during their mortgage’s term. The best type of variable mortgages offer the client an option to convert at any time to the lender’s best fixed rate offered at that time for remaining of their term. This means that if there are three years left in the term, the client can lock into the lender’s best three-year fixed rate offered at that time rather than locking into a longer term for a higher fixed rate.

Here are some good questions to answer before you decide to stick with a variable mortgage:

1. Do you want to take advantage of lower payments that a below-prime mortgage provides?
2. Do you want to pay down your mortgage faster while rates are lower?
3. Do you want to save money in interest costs?
4. Does your monthly budget allow for fluctuations in payments?

If your answer to any of these questions is “yes,” then perhaps you should consider a variable mortgage. Let’s compare a five-year variable rate at prime less 0.40% and a five-year fixed rate at 4.39% for a 25-year, $200,000 mortgage:

With the variable-rate mortgage, not only is the balance remaining in five years $7,202 less than that of the fixed-rate, but you pay less in monthly payments as well. Although it’s impossible to conclusively predict what prime will do over the next five years, variable-rate mortgages have historically outperformed fixed-rate mortgages. Taking advantage of the lower rates of a variable-rate mortgage can save you money, but the critical factor remains the golden question: Does your monthly budget allow for fluctuations in payments? If your answer to this question is “no,” then fixed rates might be a safer option.

 

You may also like these stories

• 

  Six steps to understanding the home buyer’s plan

• 

  Five things to know about pre-authorized tax payment plans

• 

  Eight things to know about mortgage life insurance

• 

  Five things to know about a gift letter