February 4, 2020 | Posted by: Harold Hagen

Possibly the number 2 question asked most often (after mortgage rate), is identifying whether a fixed or variable rate mortgage product is best for you. Although we all wish a crystal ball would show up at our doorstep, the truth is that noone can confidently forecast what will happen in the financial markets 3 to 5 years from now. Therefore, assessing whether a fixed or variable rate mortgage product is best for you rests in an understanding of your own financial plan and ability to handle market fluctuations (ie., risk tolerance).

Over the many years that I’ve been negotiating new mortgage financing, mortgage renewals, and contemplating where we are in the rate cycle, I’ve found a very simple test to help me answer this very question:

If the possibility of a quarter-point increase in interest rates will cause you to lose sleep at night or cause undue stress on your monthly budget, it’s time to consider a fixed rate mortgage.

Here are some points to consider:

Fixed Interest Rate

A predetermined interest rate that will not change during the term of your mortgage, thereby buffering your household budget from increases in market interest rate.  It does not matter if interest rates go up or go down; your rate is fixed, and your payment is fixed. 

Fixed rates are based on Canadian government bonds yields.  The yield is essentially a minimum rate of return required by investors who trade government bonds. Fixed mortgage interest rates are strongly correlated with Canadian bond rates of similar term of maturity, meaning that any change in government bond rates eventually translates into a similar change in fixed mortgage rates.

Variable Rate Mortgage

Variable mortgage rates fluctuate with the banks prime-lending rate. Variable rates are essentially determined by institutional prime lending rates, which are influenced by the Bank of Canada’s key lending rate. The ‘discount’ or ‘premium’ on prime that you receive can fluctuate with market conditions and what each lender is offering at any given time.

Some basic questions to determine if a variable rate mortgage for you?

  1. Do you have room factored into your budget if your payments were to go up?
  2. Do you follow the rates to know if or when you should lock into a fixed product?
  3. What would your rate be if you chose to lock in at some point? Is that discount in line with the wholesale rates available in the market? If it is a certain discount off of the going rate, is it in line with what is being discounted today on that product.

Keep in mind

If you are a first-time homebuyer with a high ratio mortgage, you will need to qualify at the 5-year Benchmark rate as posted by the Bank of Canada. This means that you must have the financial tolerance to afford the monthly payments as if your interest rate was actually ~2% higher.  The federal government instituted this rule to help ensure borrowers remain capable of managing increased monthly mortgage payments in the event interest rates increase considerably.

 Which one should you choose?

If you’re a person who would lose sleep wondering how your monthly budget and mortgage payments would be impacted if interest rates went up by a percentage or two, then having a fixed interest rate mortgage is probably for you. If you’re a person who can cope with unpredictability and believe that over the long term you’ll come out ahead (i.e., more green in your jeans), a variable interest rate mortgage may be the right choice for you.

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