It’s a hot topic of discussion, especially these days. After years of the Bank of Canada’s record prime rate of just 0.25%, we just had a 0.25% increase at the start of 2022. An increase that many people expected this year .
So, is locking in a fixed rate mortgage the way to go? It’s a tough decision for most people, and most people could be wrong if they don’t have a mortgage expert to guide them.
The choice is basically betting on which would be the best choice in terms of the interest you are going to pay over the term of the mortgage. For most people, this is a five-year term that they commit to. Interestingly enough, there is perhaps a more important consideration than interest cost over time. More on that in a minute….
If we look back over the past 25 years to see what would have been the better choice, it’s clear that the adjustable rate mortgage has outperformed and saved customers money over a five year period. At present, even after the recent change in the prime rate, the spread between variable and fixed rates is significant. The prime rate, on which variable rate mortgages are based, would have had to increase about five times more before even matching the current level of fixed rates.
Keep in mind that this is not guaranteed. The government may want to raise rates, but that’s something they don’t like to do when the economy is not doing well. Is the economy good right now? No. Are there all kinds of things happening at home and abroad that can negatively impact our economy? Yes. Over the past 10 years, economists have often predicted big increases in mortgage rates, and they’ve been wrong more often than they’ve been right.
However, let’s say that the prime rate increases several times more. It would probably take a while for that to happen. If we get to a point where the variable rate is equal to the current fixed rate, you would still have saved money. The prime rate should continue to increase several times over the remainder of the mortgage term, before you get to a point where the fixed rate was the best choice.
Remember I said there may be a more important consideration? Well, the problem with mortgages is that they come with penalties that often kick in if you break them before the end of the term. Despite people’s best intentions, statistically most people will break their mortgage. If you have a variable rate mortgage, the penalty is three months interest. Fixed rate mortgages have another penalty called IRD, which stands for Interest Rate Differential. In a bank, the IRD penalty is on average about ten times higher than the variable rate penalty.
A final point to note is that many people only choose the fixed rate mortgage because they want certainty of what their monthly mortgage payment will be. With most variable rate mortgage providers, when the rate changes, your payment also changes. This change really isn’t that big, only about $12 for every 100,000 of mortgage debt per 0.25% change in the prime rate. However, did you know that you can get an adjustable rate mortgage where your monthly payment amount stays the same? Only the amount of interest and principal in the payment changes.
So if a variable rate is much more likely to cost less interest over the term, has a much lower penalty if you break it early, and you could have certainty in your monthly mortgage payment, is there a reason to choose the fixed rate?
Remember that the banks have every interest in you choosing the product that makes them the most money. That’s why it helps to get expert mortgage advice from an independent mortgage broker.
Life is variable, maybe your mortgage should be too. If you would like to discuss this or any other financial matter, please do not hesitate to contact Wes Rosso of DLC Home Line Mortgage Services in Kelowna, BC.