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Should You Go With A Variable or Fixed Mortgage?


The biggest question that many Canadians will be facing over the next couple of years is whether to go with a fixed rate mortgage or a variable rate mortgage. Unlike our distant North American cousins in America, Canadians have the ritual to renew mortgages every 5 years. It’s too bad that Canadians don’t get the luxury to lock into 30 year mortgages at dirt cheap 3% interest rates.

The next two years will be pivotal for many Canadian families, especially those in expensive cities like Toronto and Vancouver where rising interest rates are putting many families into a tight bind.

This week Canada is expected to raise the interest rates by another 25 basis points (0.25%). This will bring the mortgage stress test closer to 6% and presents a huge burden on existing and would be home owners. So with rising interest rates, how can home owners protect their wallet?

Expect More Interest Rate Hikes

It should be clear by now that all federal banks across the world are starting to raise interest rates off the emergency levels established after the 2008 financial crisis. It’s taken over a decade, but it looks like the world’s economies can now hold up against rising rates.

This means that for over a decade, people haven’t seen interest rates go higher. The scary part reality is many don’t even realize what higher interest rates will do to their monthly mortgage payments.

The dilemma that home owners now must face is whether to take the lower variable rates mortgage that the bank offers or go with a fixed rate mortgage. Given the low interest rates of 2.4% for a variable rate mortgage, it might seem very enticing to keep the lower rate and have lower monthly payments, but making judgments based on short term payments is something a home owner should be wary about.

If It’s Too Good To Be True…

Variable mortgage rates hover around 2.4% right now. 5 year fixed rate mortgages are on average around 3.6%. To any home owner that is tight on cash flow, taking the variable rate might seem like the best choice because of the lower monthly payments, but heed this warning, interest rates are rising.

Throughout history, taking a variable rate was almost always a better option for home buyers looking to save money on interest. That’s because in order for a fixed interest mortgage to be better than a variable, the variable would have to average a higher interest rate over the 5 year term than the fixed.

At the current spread of 1.2% between the fixed and variable rate mortgage, it may seem like a better deal to take the variable. But wait. With the Bank of Canada poised to raise the interest rate this week, and perhaps add another hike by the end of this year, the gap between variable and fixed rates will have been halved already before the end of the calendar year.

With the proposal to continue raising rates next year, and possibly even 3 more times, that would take the variable rate from the current 2.4% up to 3.6%. This means that it’s possible that less than half way through the term the variable rate would have caught up to the fixed rate. Factor in the potential of 3 more years where the interest rate could go higher than the current fixed rate and the picture doesn’t look good.

Play It Safe

If there is any time where a fixed rate mortgage might seem better than a variable one, now might be the time. With inflation on the rise due to increased pay and possible tariffs on goods, it might not be surprising to see the interest rate rise over the next few years.

For those that want to take advantage of the lower variable rate, but protect themselves from rising interest rates, it might be a good idea to take a lower rate, but pay the monthly as if it was the higher fixed rate. This would mean a greater amount of the principal would be paid off. This strategy would also mitigate some of the losses that could be incurred when variable rates start exceeding the current fixed rate.

What you don’t want to do with a variable rate is end up paying more and more interest at the end of the term. Many variable rate mortgages have fixed payments per month, but as interest rates get higher, a greater portion of the amount goes towards paying interest rather the principal. The result is if interest rates rise too fast, the next renewal could end up being really costly.

Lock It In

If I were looking for a mortgage, I would certainly lock it in. In fact, locking in a few years ago would have been a better play since interest rates have been gradually rising. The greatest fear now is that with tariffs and a falling dollar, inflation could really pick up. This could lead to faster rate increases, don’t highly unlikely.

Since many predict there to be 4-5 rate hikes over the coming year, it just makes more common sense to use a fixed rate approach. You might end up paying more, but the fact is, it will make your finances easier to budget.

Knowing exactly how much you will be paying and how much is going towards your principal will give a better perspective on how to plan your finances over the next five years. The positive is you’ll be able to sleep better at night not having to worry if you’ll end up paying more interest on your mortgage than you intended.

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