Mortgage Rates Slowly Rising - Variable vs. Fixed?

With fixed rates up around 0.60% over the last 4 weeks (currently at around 3.49%.. there are some lower rates but these come with conditions so we are using the more widely available rate) we must again take a look at Variable rates.  

 Today’s best Variable rate product is sitting at around Prime less 0.40% … there’s even a few promotional Variables at Prime less 0.50% for qualified applicants.   But for this article we will stick with Prime less 0.40%.  That’s 2.60% today.  We are almost at that 1.00% spread that I like to see.
Two years ago, the best Variable rate was at Prime less 0.75% with the option to lock into the BEST discounted fixed rate at any time (this option is important, don’t ever settle for a variable product that doesn’t have this clause).   And 5 years ago, we had Variable rate products as low at Prime less 0.90%.

VARIABLE RATE HISTORY
Historically, Variable rates have easily outperformed Fixed rate mortgage products…  The savings has been between 1.00% and 3.00% per year.  That’s an incredible savings…  Yet, 5 year fixed rates have been the most popular mortgage products for as long as I can remember…   The BANKS love fixed rate products for several reasons… they have you trapped for 5 yrs , if you do leave or pay the mortgage early you get hit with an inflated penalty calculation, It’s also no coincidence that 5 yr fixed rate mortgages are the most profitable for the BANKS.

Putting all that aside, during the last 2 yrs, and only during the last 2 yrs, we almost had no choice but to take a 5 yr fixed rate product.  It was around 2 yrs ago that the BANKS stopped offering competitively priced Variable rate mortgages..  Pricing increased to Prime less 0.10% and even Prime.   And 5 yr fixed rates were hovering at around the 3.00% mark..

A CLOSER LOOK AT THE STATS
Another interesting fact… The average Bank Prime rate over the last 10 years has been 4.00%…. An educated guess would be to say the average discounted Variable rate product has been at Prime less 0.75%… that gives us an average rate 3.25%.   The average posted 5 yr fixed rate during that time has been 6.07%.  It’s hard to calculate what the true average 5 yr discounted mortgage rate is, as discounts have increased significantly during that time.  But an educated guess would be an average discount of 1.30%… so let’s say the average 5 yr fixed rate is 4.77%.

That’s an average annual savings of around 1.52% per year on your mortgage during the last 10 years.   Yet the Federal govt would rather have everyone locked into long term Fixed rate mortgages so that you don’t suffer a payment shock.   “The road to hell is paved with good intentions”…  For some reason, that old saying comes to mind.  Historically, fixing your rate is like buying insurance… Sure, you’re protected but it comes at a hefty price.  So how about the next 10 years?   I don’t have a crystal ball but let’s give it a try….  

FIXED VS. VARIABLE IN THE NEXT 5 YEARS
 
Let’s do a ‘what if’ scenario… Let’s use a $250,000 mortgage…  5 yr fixed 3.49% and compare it with a Variable rate of Prime less 0.50% (2.50%).   Payments would be $1132/mth vs $1246/mth.  That’s a $114/mth savings.   Now let’s increase our Variable payment to $1246/mth to match the 5 yr fixed rate….  And let’s say Prime goes up 0.50% every year for the next 5 yrs (using this to show a 2.50% increase in Prime over the next 5 years)….    The results are interesting…

After 5 years, the Variable rate borrower would be down by around $562.    Remember, this is based on the assumption that Prime rate will increase by 0.50% every year for the next 5 years…  Many experts don’t think that will happen.   Many believe Prime will increase but more slowly.   This illustration shows that Variable rate is once again proving to be a product worth considering.

We haven’t factored in the benefits of a set prepayment penalty… Variable rate is set at 3 months interest compared with Fixed rates that carry a 3 mth interest penalty or Interest Rate Differential (IRD)… And we’ve all seen BANK IRD calculations costing borrowers $10,000, $20,000 and more.  And with the average Canadian changing mortgages ever 3 years, this will actually be a good option for those with uncertain future plans or for those borrowers that are comfortable with possible payment fluctuations.

Variable Rate is on the radar, once again.  There isn’t ‘one size fits all’ when it comes to mortgages.  We all have different risk tolerances, goals, plans and needs.   It’s hard to say Variable is right for you without getting a proper analysis and product comparison.  Speak to your Mortgage Broker to get professional advice.




July 9, 2013 — Steve Garganis