The age-old question… should I go with a fixed or variable rate mortgage? Banks, spend millions of dollars advertising 5-year fixed mortgages as a “safe” choice to their consumers, yet banks are in the business of making money and paying their shareholders dividends. Have you ever paused and ask yourself what the differences? Below I will dive into and explain the differences which will make you think twice before asking for that “safe” 5-year fixed mortgage!
When clients ask for a 5-year fixed mortgage, I always ask “why?”. Generally, their response is “that’s what my friend / family / home bank suggested, and a variable rate makes me nervous”.
Most Canadians don’t fully understand the differences between fixed / variable and the potential unwanted surprises the 5-year fixed has. On average about 60% of Canadians will break their mortgage around 36 months – when that happens on a fixed rate, it will trigger a shocking penalty of approximately 4.50% of the remaining balance! Yup, that’s right… now assuming you have a mortgage balance of $400,000 that would be approximately an $18,000 fee for breaking a fixed rate mortgage. This is called IRD (Interest Rate Differential) penalty. You may argue that your bank only charges, 3 months interest, etc. but the fine print on a 5-year fixed mortgage outlines that the greater of 3 months interest or the IRD is charged upon breaking the mortgage. To me, an $18,000 fee doesn’t exactly scream “safe bet” when it’s highly likely (60%!) that you may break your mortgage at 36 months – this is why banks are so passionate about selling them… it makes them a lot of money!
You might be thinking, this doesn’t apply to me because I simply want to move and port my mortgage. Yes – in some case you can, but that’s assuming the bank approves the new house/ property you purchased, and you requalify for the mortgage amount you are looking to port/ move. If not, you will be faced with same the penalty. You may think you won’t need to break the mortgage, but life happens… divorces, refinancing to pay off high interest debt, refinancing for major home renovations, new additions to the family, moving to take a new career/ promotion and other life events. Life is uncertain, and the last thing you should need to worry about is your mortgage.
So, what’s the better option? A variable rate mortgage allows you maximum flexibility without being chained to your mortgage and the potential to face huge penalties should something come up and you need to break the mortgage. To break a variable rate mortgage, most lenders will only charge you 3 months interest penalty. So again, assuming a $400,000 mortgage, that’s approximately a $2,000 fee – I don’t know about you, but I’d prefer to save $16,000 by selecting a more flexible mortgage product.
The other fear of variable rate mortgages is the possibility of interest rates fluctuating – rates will go one of three ways – stay the same, go up or go down. On average, people who are in a variable rate mortgage end up saving money over the life of the mortgage due to fluctuating rates. At the time of writing this blog (Sept. 2021) there is a notable difference between a 5-year variable and a 5-year fixed – the current 5-year variable rate is 1.40%, whereas the 5-year fixed is 2.09%. Based on a mortgage of $400,000, that’s $1,580 / month for someone with a variable mortgage and $1,711 / month for someone with a fixed mortgage. That’s a savings of $131.00 / month!
The other failsafe on a variable rate mortgage, is that should rates start to climb and you begin to get nervous, in most cases, you are able to convert your mortgage to a fixed rate. Should you remain in a variable rate mortgage, remember that you aren’t necessarily losing money, you are simply giving back some of the earned savings. Something I always recommend to my clients is to take the variable mortgage, but pretend you are paying the fixed rate from day one. With the additional savings, stock that money away and you’ll have a cushion if rates start to increase.
If you’re interested in learning more, please free to call to discuss your options.