What is the benefit of a variable rate mortgage?
What is the rate compared to the 5 year fixed rate?
Historically the prime rate has been lower than the five year fixed rate . A variable rate mortgage uses the prime rate or a discount off the prime rate to determine the interest rate you pay. The rate may change with an increase to the prime rate but it can also offer you a better interest rate. in the last 40 years there has been one period in time where a fixed rate made more sense financially than variable rate, 1979-1984. If you had taken a 5 year fixed rate in 1979 at around 11%, you would have avoided the prime rate increase to around 19% in 1980-81. The advantage of taking the variable rate over the 5 year fixed rate can save you money for the life of your mortgage from a historical perspective.
The Bank of Canada has been hinting at an increase to the prime rate but the savings could still be passed along to you. In the case of a prime rate increase there is the opportunity to lock into a 5 year fixed rate at any time. Trying to time the market at the low point in an interest rate cycle is a difficult strategy. Locking into a 5 year fixed would then give you the benefit of the stable payments if the rates increase while the time spend in the variable portion gives you more time to reap the benefits of the low interest rates. For example if you take a variable rate mortgage today and in 2 years the prime rate goes up, you can lock in your mortgage at a 5 year fixed rate. This would then give you 7 years (2 in the variable rate and the 5 year fixed) of the lower interest rates.
Variable rate mortgages are not for everyone as there is the chance of the rate going up. Ask yourself these 3 questions to determine if it is a fit for you.
- Can you sleep at night knowing your payment may increase?
- Do you have the opportunity to make more money or cash flow for a payment increase?
- Can you check and read your emails 8 times per year?
If you answered yes to all these you are the right fit for a variable rate mortgage. An added service I provide clients who opt for a variable rate mortgage is that I communicate via email on every Bank of Canada rate announcement day. This information will give you all the details about the prime rate, recent news about the trend in the prime rate and the possible changes in the market.
Here is a look at the historical data from the past 25 years of the prime rate vs the 5 year fixed rate: historical rate sheet – one link