With mortgage rates currently at all time lows, many of my clients are asking if they should take fixed over variable. Both have pros and cons and the answer depends on each client's individual situation. When presented with this question, I generally ask my clients the following: what is their current appetite for risk and what is their short term and/or long term plan for the home in question. Let's examine some of the key differences and how they can affect your finances.
A fixed rate ensures your payment will stay the same over the entire term of your mortgage, however a variable rate will change with the prime lending rate as set by your lender (currently 2.45% in Canada). The prime lending rate can fluctuate over the term of your mortgage, however the relationship to the prime rate will stay the same over the term of your mortgage (prime less 0.60, etc). Some clients view a variable rate as more risky than a fixed for this reason as we cannot entirely predict the Bank of Canada's forecast for prime rate. The Bank of Canada adjusts the prime rate depending on the economic state relative to various factors such as unemployment, inflation etc, however variable rates tend to be lower than fixed rates at any given time. Coincidentally, most lenders offer the option to lock in the variable rate by simply calling into the servicing desk or going into the branch at no additional cost to the client. With the Bank of Canada renewing it's pledge to keep the prime rate low until the economy recovers, there has never been a better time to explore the option of a variable rate.
Significant differences in prepayment penalties can also play a large factor in the decision process. Most banks and lenders have an IRD penalty (interest rate differential) on a five year fixed mortgage, which is quite large in comparison to a three months interest penalty that is generally standard on a variable rate. Different lenders will calculate their IRD penalty in slightly different ways, but it is based on the difference between the posted rate at the time you obtained the mortgage and the current rate or discounted rate offered by the lender at the time you choose to break your contract. On a fixed term, you will always pay the greater of IRD or three months interest. On a variable rate, you will pay three months interest regardless. Many clients are not aware of this difference in penalty prior to making this decision, which can impact them greatly at a later date.
There will always be a significant level of comfort in locking in a super low five year fixed rate as the rate has no option of fluctuation, however; if you are unsure of your long term plan for the home you are refinancing or purchasing, a variable rate seems to be a no-brainer in today's current market. Again, this is dependent on several varying factors and unique to each client's goals, therefore it is important to explore both options with your mortgage broker and come to the best decision for you. There is no right or wrong answer to this, however, a lower penalty and lower current rates combined with the option to lock-in at a later date, seems like a good time to take a risk if you ask me.
