Should You Get A Fixed Or Variable Rate Mortgage?

Whether you’re buying a home or looking to renew your mortgage, you’ll need to choose between a fixed or variable rate mortgage.  That choice has become more difficult lately as the spread narrows between fixed and variable rates.

Ever since prime rate bottomed out at 2.25% back in April 2009 most of us predicted interest rates would return to historical levels as the economy recovered.

Related: My Biggest Home Buying Regret Was Getting In Over My Head

Indeed, by September 2010 prime rate inched up 75 basis points to 3%.  But we haven’t had a rate increase since, and, with the global economy sputtering along, it doesn’t look like that will change anytime soon.

Interest Rates Expected To Rise: But When?

When I wrote 20 simple steps to improve your finances back in December 2010, my first ‘step’ was to switch to a variable interest rate mortgage.

The first comment agreed with the list, but echoed what many others were saying about mortgage rates at the time:

“Interest rates in Canada are due to rise with most experts believing they will go up 1-2% over the next year. Locking into a 5-year fixed term now is the smarter way to go.”

I believe that you’ll save money when you take either the 5-year closed variable rate mortgage, or the 1-year fixed rate mortgage, whichever is cheaper.

We bought a new house in August, 2011 and I put my money where my mouth is by taking out a 5-year closed variable rate at 2.2%.

Related: More Hinting At An Interest Rate Hike

Best mortgage rates

Okay, so that’s great for me but what if you’re looking for a mortgage today?  Here’s a chart that compares the best mortgage rates in the country as of April 12th, 2013:

Term Interest rate
5-year variable 2.50%
1-year fixed 2.39%
2-year fixed 2.49%
3-year fixed 2.54%
4-year fixed 2.77%
5-year fixed 2.79%
10-year fixed 3.62%

*Source: LowestRates.ca – Compare mortgage rates in Canada

The difference between most 5-year fixed rates and 5-year variable rates is less than 0.5%.  Interest rates are so low that it’s hard to go wrong with any of these terms, but you’ll want to look beyond the rate and consider all the features you’ll need with a mortgage.

BMO’s controversial 2.99% ‘no-frills’ mortgage came with a few restrictions, like a limit to how much you can pre-pay or increase your monthly payments.

There are fully featured mortgage products available at these rates, so it’s best to do your research.

Fixed or Variable Rate Mortgage?

I stand my belief that you’ll save money with the better of the 5-year variable rate or the 1-year fixed rate mortgage.  Today, that means taking the 1-year fixed rate.

Related: Pros And Cons Of Going Short With Your Mortgage

You’ll pay $7,039 in interest at 2.39% for one year on a $300,000 mortgage.  Compare that to the 5-year fixed at 2.79% and you’ll pay interest of $8,216 in the first year.  That’s nearly $1,200 in savings!

Then, when it’s time to renew in a year, you can take another 1-year fixed or watch for a really good discount off the 5-year variable rate (prime minus 0.75% or better).

Final thoughts

Banks and brokers are always screaming for you to ‘lock in’ now before rates go up.  That’s because banks make more money on 5-year fixed rates and they use the fear of rising rates to scare you into locking in to a longer term.

Related: Why I Don’t Use A Mortgage Broker

Do you think your bank would be lending you money at 3% for five years if they thought they’d have to borrow at a higher rate in a few years?  The banks are rarely on the losing side of a deal.

In Moshe Milevsky’s popular study, “Mortgage Financing: Floating Your Way To Prosperity”, it’s noted that:

“Canadians who can accurately predict the next move of the Bank of Canada – and decide to “lock in” their mortgage when the short rate is about to increase – are worse off on average, compared to those who float over the entire interest rate cycle.

This is due to the fact that in order to properly time the mortgage “lock in” market one requires an ability to predict movements on both short and long term points on the yield curve, which is a skill that even the Governor of the Bank of Canada is unlikely to possess.”

What do you think?  Should you get a fixed or variable rate mortgage today?


25 Responses to Should You Get A Fixed Or Variable Rate Mortgage?

  1. I am very cautious and I can’t afford to take any chances so I would take the 5 year fixed.

    If it was my first mortgage I would be spending some serious time with the online mortgage calculators figuring out the differences between the amounts I would have to pay between the 5 year fixed and the 10 year fixed.

    A young couple who thinks that their income may be lower in 5 years because 1 of them may be home with young children might consider the 10 year fixed. I know I am super cautious but I have been in a period of very high interest rate in the early 90s and it was a struggle. Interest rates could rise dramatically.

    • Echo says:

      @Jane – Milevsky’s study went back 50 years and included the double digit rates between ’78 – ’91. You still saved money with the variable rate 9 times out of 10.

      If you’re cautious and can’t afford to take any chances, why not go for the variable or 1-year fixed where you’re almost assured of saving money?

      Yes, interest rates could rise dramatically, but you’ll also have to renew your 5-year fixed rate at a higher rate.

  2. As Jane notes, you’ve completely ignored the risk of higher interest rates. That risk can mean anything from higher mortgage payments, right up to losing your home. You may not see that risk as something you want to cover, but it’s absolutely something that needs to be reviewed thoroughly and addressed by readers.

    The probability of that happening may be low, but it’s not 0. And the results of a dramatic increase in interest rates leading to a home loss are catastrophic. And the easiest way to insure against that increased interest rate? Lock in your mortgage rate for 5+ years. The cost of the difference in interest rates is simply the cost of the insurance to know that for the next 5 years you can afford your mortgage payment.

    I would also question your assumption that the banks have any idea where interest rates are going. Offering you a 5 year locked in rate doesn’t require them to know what future interest rates are going to be.

    • Echo says:

      @Glenn – Fair point. But you do realize you can lock in your variable rate at anytime, right? Also, a bump in prime rate doesn’t mean your payments go up – it just means more of your payment will go to interest, not principal.

      If you want to pay a premium for predictability, that’s fine. But going short or variable with your mortgage is NOT like walking around without life insurance. Especially when you’re likely to save money 9 times out of 10.

      • No – it’s exactly life life insurance. You know how many of my clients could save money by cancelling their life insurance? All of them.

        9 times out of 100 they’d save money. It’s that one time in 10 that’s a real bummer. Just like the small chance of rates skyrocketing. And if you haven’t considered the risk of skyrocketing interest on your home ownership, considered the potential costs and ramifications, then you’re not financial planning but are just being foolish. That doesn’t mean you take the fixed or the variable. It means you need to consider and address the numbers.

        • Echo says:

          @Glenn – You’re ignoring the fact that, according to the Milevsky study, people still saved money with a variable when rates rose dramatically in the 80′s.

          And his study used prime as the variable rate. A discount off of prime would further increase your chance of success.

          If I’m not mistaken you still need to qualify at the banks’ posted rate if you take a variable rate mortgage, so you’ve got a built in safety net already.

          We chose to keep our payments as if we were paying at 5% instead of 2.2%.

  3. krantcents says:

    With interest rates so low, I would go with a fixed rate mortgage. The only exception is if you were planning on selling in less than 5 years.

  4. Dan says:

    I think the point of the article is that the premium paid for predictability/stability (ie. fixed rate) is so high that 9/10 times you save money with a variable rate. The fact you can lock in a variable rate (to a fixed rate) at any time means there is even lower risk with a variable rate mortgage.

    I don’t like how buyers are always pushed towards the 5 year fixed rate using the fear factor – the banks sell it as ‘stability over a longer period’ but they make much more profit off a 5 year than anything else

  5. Adina J says:

    Since I don’t really have a choice at the moment, this is all a bit hypothetical for me, but … I wish I hadn’t locked in to a 5 year fixed term back in 2006 … which led me to having to be locked in again when I sold my first place in 2010 and bought my current house. I’m pretty sure I paid a ton of extra interest in the last 6 or so years. But I was very risk averse in 2006, and I wouldn’t have dreamt that rates would end up at these levels a few years later.

    • Echo says:

      @Adina – It’s interesting to read these types of posts going back to 2006-2007. Rates were 5% then and proponents of fixed rate mortgages were saying the same thing – “Lock in – Rates have nowhere to go but up!”.

      They said the same thing in 2009 after prime rate bottomed out.

      Everyone wants to believe this time is different.

      Heck, even my natural gas plan is on a floating rate and Enmax wants me to ‘lock-in’. Why do you think that is?

  6. Bet Crooks says:

    I suspect there are a lot of us out here who can’t sleep easily without a fixed rate. I figured I paid for insurance I was unlikely to ever need and paid a huge amount of taxes for services I largely hope to never need. So I figured we would be overpaying with a fixed rate locked in, and we probably did. But knowing exactly what to expect for years on end was very calming. We also went fixed rate because of expected upcoming self employment issues. That said we had a 25 year amortization and made the last payment in under 15.

    Has anyone compared the financial benefit of accelerated payments, increased payments and lump sum payments vs (fixed vs variable)? I suspect the single most important thing would be making big additional payments against the principal every year. We could pay 20% of the ORIGINAL principal every year with no penalty even though we were fixed term/rate.

    • Echo says:

      @Bet Crooks – If you go bi-weekly you’ll knock down your amortization from 25 to 21 years. Any additional payments will reduce your amortization even further. You can do these things whether you go fixed or variable. The variable comes out ahead because you’ll pay less interest over the life of your mortgage.

      I understand the ‘sleep at night’ argument but I sleep better knowing I’m saving money.

  7. Bryan says:

    We are 71 days away from closing on our new-build house! Very excited and obviously shopping for the best rates possible. Amazing how bigger companies, we went to Scotia and Meridian Credit Union, will instantly push the 4 or 5 year fixed when we stated we want a 1 year fixed or 5 year variable. I just kept thinking “I know exactly why you want me to do that!”.
    So I have instead turned to ratesupermarket.ca and lowestrates.ca as well. And my question is this: are all of the companies that appear on these sites as, “legitimate” as the big banks? Premier Mortgages and Advent Mortgage Services are 2 I have spoke with over the phone, but don’t know anything really about them. Can they all be trusted? Is there a chance I get scammed at all by these companies? Or is that absurd and I’m paranoid?
    I know you have recommended them in the past, so do you use them as well to find your mortgages?
    Thanks as always!
    Bryan

    • Echo says:

      @Bryan – I doubt you’ll get scammed because these brokers will likely get you a rate at a big bank or credit union.

      Do your homework though. I’d take the information you find online and then go to your bank and ask them to match. The mortgage market is competitive and you should get a good deal if they know you’ve been shopping around.

      One reason I don’t trust some mortgage brokers is because they post information like this – http://screencast.com/t/ZoUqEixq5Kk

      C’mon, what bank is offering 6.4% on a 1-year closed? It’s misleading because they’re trying to show potential customers (who don’t know any better) that they can get you a rate that’s 4% better than your bank can. Ridiculous.

  8. If we weren’t paying our mortgage in full next month our 5 year fixed term would come to an end next April. One thing we would do and like you mention is look at all the restrictions. That sometimes can make or break a deal. It may seem like the best rate but the perks backing it aren’t as great. Comparison shopping, sure that make sense. Our 5 year fixed is 3.99% so it’s much lower today and that was from 2009.

  9. Shafi says:

    We just refinanced at less than 3% interest. Because interest rate is still low, I would go for fixed rate mortgage.

  10. Joe says:

    I can’t believe I’d be better off in a variable rate when I’m paying 3% for a five-year fixed, not now that Prime minus 0.6% mortgages are gone.

    If this were America, where a 30 year mortgage can be found for under 4%, this wouldn’t even be an argument — go fixed. In fact, I’d have bought a bigger/nicer house rather than planning to upgrade down the road. But it’s Canada where our banks relentlessly screw the average person and then replace their ever-shrinking employee base with illegal foreign workers. Not paying interest to them after my 5 years of mortgage is done. No way.

    • Echo says:

      @Joe – Well, you’ve already paid more interest than you would have with a variable or a 1-year fixed. Every month that goes by without a change to prime rate just widens that gap.

      • Joe says:

        Yes, but in corporate finance it’s important to consider risk in an NPV analysis. Fixed presents 0 interest risk for five years. Variable presents significant risk. Not sure what I’d value it at, but it’s a real consideration to include and it’s not presented in the analysis.

        • Echo says:

          Depends how you define ‘significant’ risk. We’ve already established that your payments won’t go up and that you can lock in at anytime if you get queasy.

          So, you’ll always know your monthly payment. You have the chance to lock in if rates go crazy. And you’ll sleep better at night knowing that the odds of saving thousands of dollars over the life of your mortgage are overwhelmingly in your favour.

  11. KC says:

    The one thing that I have noticed is that banks offer a wide variety of perks and restrictions on mortgages leading some people to go with fixed instead of variable so it can be quite confusing. Of course, some people worry about the rise in interest price as the vast majority of them are only one paycheque away from losing their home which points out a bigger issue than mortgage interest rate!

    As I don’t own a house right now, I really can’t say which one I would choose. However, as I am an accountant, I am a bit more conservative so I would try to choose a hybrid of sorts.

    Bottom line, everyone has to be comfortable with the rate that they choose. If it means paying the premium for reliability/predictability, so be it and that’s their choice as long as they have done their research.

  12. The only time I recommend my clients NOT do exactly what you’re suggesting is if they don’t want to be on top of thier mortgage all the time. Otherwise, this is the right way to go. I’ve found often though, that when I suggest Boomer’s route, people don’t want to do it simply because they want to get a mortgage and forget it. They don’t want to have to renew, they don’t want to have to stay on top of rates all the time. For those looking for a “get it and forget it” mortgage, a fixed is the right way to go. And as usual, those who don’t mind taking the time to do their due diligence will get a bit of savings for it.

  13. G says:

    Hi There,

    I know I’m a few months late to this post, but I find myself in a similar predicament where I’m deciding between variable or fixed. I currently have a 120 day hold on 2.89% fixed for 5 years. This rate expires at the end of the month and was secured through a mortgage broker. However, my financial adviser has advised me to take a closed variable at 2.5% for 5-years. My concern is that the spread of 39 basis points between 2.5% and 2.89% is not high enough to take the risk of going variable. I understand that rates are probably not going to go up significantly in the future, but I would assume rates would go up a little and perhaps catch up to the 2.89% or exceed it.
    what are your thoughts? Any advice would be helpful.

    Thanks.

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