Fixed vs Variable Mortgages (to lock in or to float)

The Canadian mortgage markets have shifted and there is a legitimate conversation for the choice between fixed and variable mortgages.  For the past two years the variable rate mortgage has been a poor choice for most clients.  This is a result of the fixed and variable being almost the same rate, for example in May of 2013 we have five year fixed rate mortgages at 2.79% and five year variable mortgages at 2.70% (prime -.3).  When the rates are as close as they were, unless there is a very specific reason for wanting a variable, the best choice for almost all of our mortgage clients was to select a fixed rate.

 My personal rule is that once there is a 1% or larger gap between fixed and variable rates, then the variable is definately worth considering.  

Currently we have a gap of 1%, with the fixed rates being ~3.59% and the variable being ~2.60%.  My personal caveat is that although I will explain a strategy that we have used with many of our clients and have had tremendous results with, there are some clients that are truly a best fit for the fixed rate and I would never fault anyone for selecting the current fixed rates as they are historically excellent.  Now onto the fun part….

The Fixed vs Variable Mortgages strategy:

We like to work with our variable rate clients on an inflationary hedge strategy – that is a very fancy sounding word that means we will set your payments higher than you are currently being charged on your variable mortgage so that we can pay off your mortgage much faster and guard you against future rate increases.

Lets look at an example:

Assuming a $300 000 mortgage and a 25 year amortization.  The monthly payment with a fixed rate at 3.59% is $1512 and the variable mortgage payment is $1359.

With this strategy we would approve our clients for the variable mortgage with a 25 year amortization but after funding set your payment to the same payment as a 3.59% fixed 25 year amortization.  This would result in you being charged interest for your mortgage with a payment of $1359 (the variable rate) but you paying extra funds toward the principal of $153  per month ($1512 – $1359).  This will hedge you against future prime rate increases while at the same time helping you repay your mortgage faster.

In this case, if the prime rate stays the same throughout your entire term, this strategy would reduce your amortization from 25 years to 21 years and 9 months and save you $14 580.32 in interest.  Being conservative, if we assume for the first 2.5 years prime is unchanged and for the last 2.5 years prime is increased by 1% to 4%, you will not notice the increase in prime as we are already paying at a higher amount. Furthermore your savings would be about half of the above numbers, with your interest saved being about $7200 and your amortization reduced by about 1.5 years.

Some additional numbers behind the Fixed vs Variable Mortgages Strategy:

With the above numbers this strategy works great as long as we have a level or decreasing Bank of Canada prime rate, so the question is do we anticipate the prime rate to rise?  and if we do, when?

The answer is we absolutely anticipate a rise in the prime rate however as per the most recent Scotia Bank economic forecasts, they are projecting that we will not be seeing a rise in the prime lending rate until at least 2016.  The summary of the Scotia report is available here.  If we assume the typically conservative bank forecast to be correct, and we reference the above example and assume that the prime rate will remain unchanged for at least half of our mortgage term then you stand to gain over $7000 in saved interest and a 1.5 year reduction on your mortgage amortization by using the fixed vs variable mortgages strategy.

In summary:

We are actively implementing this strategy and several others with many of our clients and I would love for you to be one of our clients as well.  Please feel free to contact me at my direct line at 403-802-7201 so we can discuss your mortgage options and how we can work together to save you thousands in interest and cut years off of your mortgage.

Rylan Hahn for the fixed vs variable mortgages strategy