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Variable or fixed rate mortgages?
June 11, 2016
6:57 pm
Savings
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I am going to be renewing my mortgage soon. And was wondering if getting a good fixed rate mortgage is the way to go now? I heard that in general variable rate mortgages you end up paying less interest in the long run. Any comments?

June 11, 2016
7:10 pm
Loonie
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It depends entirely on whether interest rates go up or down during your term.
If they go up, you win with variable; and vice versa.
For a number of years now, rates have been going down or holding steady most of the time. So, people who took variable rates during that time have indeed done better than those who took fixed. Will this continue to be the case? Get out your crystal ball!

In general, when you are at the beginning of your mortgage, you don't want to take the risk of rates going up so you are safer with a fixed rate, because you know it won't turn into something you can't handle before the term is up. When you're further along with your mortgage, you may be more able to take the risk, so you might be more comfortable with variable.

June 12, 2016
8:50 am
Norman1
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One does end up paying less with variable and one-year mortgages in about 85% of the time. Professor Moshe A. Milevsky has studied this:

"Mortgage Financing 2007: What Now?" (M.A. Milevsky and B. Walker) September, 2007.
"Mortgage Financing: Should You Still Float? Four Answers." (M.A. Milevsky) April 2004
"Go with the Float? Fixed-rate mortgages offer piece of mind, but not much else." (M.A. Milevsky) National Post Business magazine, April 2001

Essentially, when one locks in for five years, one ends up paying a premium to the lender for five years of stability in mortgage payments.

June 12, 2016
1:52 pm
Bill
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Loonie, I agree, but you say "If they go up, you win with variable; and vice versa." I think you meant to say if rates go up you lose with variable, and the rest of your post seems to assert that. In any case, since the Twin Towers were knocked down in 2001 and exacerbated by the subprime loan fiasco, we have been generally in a long-term downtrend for rates and now that there's acceptance of a concept like negative rates in the mainstream discussion, well, you know something wacky's up. So the crystal ball has been very cloudy for some years now. And I'm not sure how closely the last 15 years or so can be related to "normal" (if there is such a thing), long-term data.

June 12, 2016
2:25 pm
Loonie
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Yes, Bill, that's what I meant. Sorry for the confusion.

June 12, 2016
7:25 pm
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So far, I haven chosen variable rate mortgages. In 2006, I was given a variable rate of prime minus .7%. Then in 2011, I renewed with a variable rate of prime minus .9%. Not sure if I should try to get a good fixed rate instead, as rates are much lower than 10 years ago.

June 12, 2016
10:45 pm
Loonie
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So, you're 10 years into your mortgage.

There is reason to think either way on interest rates at the moment. Mostly it looks like they will stay down, but if inflation starts to soar, which is already beginning in some sectors (food, electricity, houses in TO and VCR, etc.), that could help push rates up.

If you've got some wiggle room in your budget, you could try locking in, so that you know where you're at, and then use any surplus to pay it down further whenever your contract allows. Depending on the amount of the mortgage and your income, you might be able to just get rid of it in a few years. Knowing your rate is fixed insulates you from nasty future surprises, so that you can afford to pay it down ahead of time without worrying if that would leave you short for later payments if the rate should rise.

Rates don't have much further to go (down), so the risk on that side is finite and not very big. If rates go up, the sky's the limit, although very unlikely to go that far that soon

Norman1 is correct. You always pay somehow for security. Still, it's the other 15% of the time that you need to also think about. To my way of thinking, nothing seems very "average" at the moment, with rates that are just about, if not in fact, the lowest in history. Milevsky is a scholar I respect. However, rates were much higher when he made those comments.

If it were me, I'd lock in and try to pay down as much as possible as often as possible and just get rid of it asap. But my personality and priorities etc are not necessarily the same as yours.

One thing you can do which is always a good idea is to make sure that you have good opportunities for advance paydowns written into your contract.

June 13, 2016
7:58 am
Brimleychen
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In my own opinion, fixed vs variable is kind of whether you want insurance of certainty with a price. All the financial decisions come with this type of form. You are betting against your mortgage investors.

The simple question : can you take the risk?

Warren Buffet, Bill Gates, etc, never bought himself any insurances because of his fortune and risk torelance.

June 13, 2016
8:09 am
Rick
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When I took out my first mortgage in 1982, I asked the same question. A friend of mine said "If you lock in, at least you can count on stable payments for the next five years and budget accordingly. You wages will probably go up in that 5 years" The rate at the time was 14%. If I could have locked in at today's rate, I'd have taken out a ten year term. I know...14% of 85,000 is still a lot less than 4% of 500,000, but my wages are also more than double now than what they were then.
I don't think there's a definitive answer to your question. Everybody has their own unique situation. Are you 1/2, 2/5 or 1/3 into your mortgage? Are you able to lock in if/when rates go up? If so, how high do they have to go before you can't afford the payments and would it cost you or save you money over locking in now? If rates double, triple or more when your term is due, will you be able to afford the new rates? Can you afford to pay extra every month or year to reduce the principal? Are you a gambler or prefer security? I'm with Loonie...pay down as much as possible when ever possible. I'm surprised rates have stayed this low for this long. Will they stay low for another 5 years? Who knows. Will they stay this low forever? Highly unlikely. So hope for the best, but prepare for the worst. If rates do go up significantly, a lot of people will be unable to afford to remortgage, which will have an effect on property values and your equity. Good luck whatever you decide to do.

June 13, 2016
11:07 am
Bill
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I'm in the get-rid-of-the-mortage-asap crowd. In my 20s I bought my first house and was ready to hunker down with a 30-or-so year payment schedule when I met a 20-something co-worker who had just paid off his house. I'd never even thought of that concept, thought it made sense, so we lived on as close to zero as we could (I won't bore you with the sordid details of our Scroogy-ness during that time) and paid off our mortgage by age 30. And we've resisted the urge to "move up", raised our family there, it's still the family home. (Another essential detail is we removed ourselves from the GTA - much more reasonable prices, among other advantages.) The only downside was I could never participate in the mortgage-complaining discussions & interest rate worries of my friends and relatives but otherwise for us it's been a very good call. Just an idea someone else might find interesting.

June 13, 2016
5:17 pm
Loonie
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Bill - you mean you didn't remortgage your home every 5 or 10 years to get more equity for vacations and a "better" lifestyle or move "up" regularly or pay your gambling debts??sf-wink

January 16, 2019
6:24 pm
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My son just bought his first house yesterday.It closes in Apr/30th.He has been pre-approved for financing & asked my opinion about fixed or variable term.3.15% variable for 5 years or 3.64% fixed for 4 years or 3.74% fixed for 5 years.I personally like the 5 year fixed,knowing payments remain the same.He is a bit of a gambler.From articles I've read the variable rates generally end up better in the long run.Any thoughts would be appreciated.

January 16, 2019
6:48 pm
Norman1
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What I wrote in 2016 still holds today.

One ends up paying less about 90% of the time with a short fixed-term or a five-year variable mortgage.

January 16, 2019
9:37 pm
Loonie
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Since he's at the beginning of his mortgage and, presumably, early in his career as well, I would look at his entire financial situation before deciding on which payment system to use.

Questions such as how secure is his employment situation? what would he do about the house if something happened that he couldn't carry the mortgage? does he have a healthy emergency fund? etc. are relevant. If he doesn't have solid answers, then I would go for the five year term at this time. The first five years are the most challenging, IMO. Perhaps, when he renews in five years, he can afford to take the risk of a variable rate as he will owe a bit less and should have a higher income.

However, if his situation is secure, if he'd be willing to sell or take in a roomer/boarder or basement dweller if necessary, if he'd be willing and able to curtail other expenditures if he had to, if the bank of mom and dad is available as a last resort, and if he's a generally responsible person, then I might risk the variable rate.

Variable 3.15 could reach or even exceed 3.74 before five years are up if we remain in a rising interest environment. We saw that much of an increase last year alone - at least on the depositor side. To use one random example that is very convenient for me to access, the one-year average GIC rate at Hubert went up from 2.25 to 2.95 between Nov 2017 and Nov 2018, and has since gone up to 3.10 . If he'd bought in Nov 2017 with a variable rate, he might be kicking himself now or within the next while. We may still be in one of those 10-15% of time periods when fixed is better, but we don't know, so that is why the other considerations are so important. I don't really think it's about guessing which way the wind blows; I think it's about assessing your personal situation overall.

It's a good sign that he asked your advice! sf-smile

If he takes the variable rate, he should look aggressively at prepayment options. Try to pay off extra principal and shorten the amortization whenever possible. Not everybody supports this idea, but, personally, i believe we are heading into very uncertain times, so I would want to get rid of debt asap so as to be better positioned to deal with other issues. He needs to consider where he stands on this, and make a decision that fits his understanding and expectation.

January 17, 2019
5:02 am
Alexandre
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My mortgage had an option to do prepayment of principal for any amount. Without penalty.
I suggest shopping for mortgage with that option.

When I signed for my 25 years mortgage, my situation was quite different than 5 years later. After 5 years I realized that with my income, which was steady and increasing, I could start aggressively prepaying mortgage, which I did. By the end of next 5 years, my mortgage was paid of.

I bought my house in 1999. I signed for fixed rate, as I wanted to have predictability for my monthly expenses. I told myself: suppose, monthly payments to the bank are my rental fee. If I can afford to pay so much for rent, I can stay with it - and my rent won't change for the next 5 years, till bank will review interest payments.

Looking back, I may have saved money by going with variable rate, because rates started to decline post-2000. Yet, I would have had more stress over what my payments to bank would be if rates went up.
I've chosen to live less stressful life.

Interestingly enough, after first 4 years of my mortgage my bank contacted me with the offer to renegotiate mortgage for next 5 years with 1% less interest. Meaning, even before first 5 years term expired. Rates were going down, so bank was aiming at keeping me by giving a preemptive offer.

I could have shopped for a better rate with the different bank, but I already knew I'll be prepaying mortgage fast, so I took the deal.

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