Variable V.S. Fixed

Variable interest rates have advantages. As do fixed interest rates. They both also have their disadvantages. This is why when deciding between the two; it becomes a very difficult decision. You can either have the stability of a fixed rate or you may feel more comfortable choosing a variable rate which has its potential risks, but also its rewards.

Over the past few years interest rates have dropped to a historically low level. And in inconceivable disbelief, many have chosen to take the fixed rate over the potential savings of a variable rate to rest assured with a peace of mind. However, confidence in our economy is putting pressure on the long-term interest rates. Because of this many are turning to variable rate mortgages as a more eye-catching short-term option.

According to a mortgage consultant for Invis (one of Canada’s largest mortgage brokerage firms) the variable interest rate is now around a full point cheaper than a fixed rate. There is a continuing rising spread between short and long-term rates. So even if the interest rates rise, homeowners who have a variable rate will have more of an advantage. A variable rate mortgage allows the borrower to take advantage of low rates -- the interest rate is calculated on an ongoing basis at prime minus a set percentage. This part can be confusing so to clarify it here is a little example. First of all, prime is the best rate that banks use in pricing loans to their best and most creditworthy customers. If a bank has its prime lending rate set at 4.50 per cent, the holder of a prime minus 0.50 per cent mortgage would pay a 4.00 per cent interest rate, until the prime rate changes.

In my opinion, the best advice is to choose a variable rate. So why choose a variable rate now? Here is another example to better illustrate the reason.

A homeowner has a property loan for $250,000 and has $125,000 remaining to pay on it with a 25-year amortization period (the number of years it takes to pay off the loan by making the minimum monthly payment). Their minimum monthly payment is $716. So let’s assume the prime increases over the next five years to 5.75 percent. This equals out to a 0.25 increase per year. The homeowner has chosen a variable rate at prime minus 0.60 percent. Because the homeowner chose the variable rate, over the five-year fixed rate it would end up saving him/her $3,129. The prime variable rate would have to increase in the next five years to 6.75 percent in order for it to become an unattractive option for homeowners. Over the last 50 years, research shows consumers would have been better off by borrowing at a prime rate rather than at a five-year fixed rate 88% of the time.

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