Fixed vs. Variable Mortgages (updated version)
Things I want you to know, let's get right to it. 😊
Fixed mortgage features (main ones)
#1 - fixed rate and payment
#2 - if you break this mortgage early you will be subject to a penalty of;
the HIGHER of
a) 3 months interest (pretty cheap) or
b) Interest Rate Differential - it hurts to even say it. You would never forget an IRD penalty. Hear about someone paying a $20,000++ penalty? They hit IRD.
Variable mortgage features (main ones)
#1 - fluctuating rate and payment (true variable mortgage)
#2 - if you break this mortgage early, the maximum penalty is 3 months interest (pretty cheap) at any point in time.
I can tell you all day that the variable has been the best historically (which it has) and that it also has the cheapest penalty if you ever have to break the mortgage (which it does), so then WHY isn’t everyone in the variable?
Comfort. The King of all decision making. I have been involved in mortgages for almost 25yrs and that is my answer. I remember a client years ago, she had a family member who convinced her to go into the variable. That poor lady called me weekly concerned rates were going to take off (fixed rates change with the bond market so you don't hear as much on the news when fixed changes). We ended up switching her to a fixed because it wasn’t about rate, it was about her level of comfort. I can also tell you that I try to give clients 2-3 lender options when you find your new home (it lists quirks, lender details you need to know etc so you can make an educated decision) and probably 60%-70% of the time, the client does NOT end up choosing the lowest rate. WHAT!?! Nope. When you could be hit with a $3,000 property tax adjustment at one lender for a .05% difference in rate, people tend to care less about the .05%. (I review property tax adjustments with you before you pick your lender).
For the client mentioned above, the variable concern for her was rates taking off, she could however, afford the payment fluctuations. And there it is – the number 1 reason people fear the variable…what happens if the rates take off and I can't afford my payment. I GET IT. But then I will see the penalties that come off a fixed term if you have to break it, and it forces me to continually re-evaluate even my own comfort levels.
So let’s put this into perspective, you have a $300,000 mortgage, 25yr amortization, 5yr variable at 3.50% and the Bank of Canada says they are increasing it. THE FEAR SETS IN and the 6:00 news confirms the sky is indeed falling. So let's deal with the payment concern, please note the below numbers are for comparative purposes only, I am also using $300,000 against all rates (even though you would have been actually paying it down and have less amortization in the variable as you go).
Start: 3.50% = $1,497.81/mo
UP TO 4% = $1,578.06/mo
UP TO 4.5% = $1,618.98/mo
UP TO 5% = $1,744.81/mo ---NOTE--- the 5yr fixed rate at this time is approx 5% so had you taken fixed, this would have been the payment throughout.
UP TO 5.5% = $1,831.17/mo
First, the above assumes it only goes up. The Bank of Canada can raise, reduce or hold. There is NO right or wrong to how you feel about the above. Some will say no, I want to know my payment and that's it. Others will no longer fear variable rate increases and try to benefit from the lower rate as long as possible.
SO ARE YOU ADVISING THE VARIABLE? OR FIXED?
Good try, thats YOUR decision. I am here to help you be informed so that you can make the best decisions for yourself. I am of course always happy to chat about it with you further as well.
WHAT ARE RATES GOING TO DO?
HA. I will tell clients what we've been HEARING briefly but thats as far as that topic goes. At the end of the day, we don't REALLY know. We may have indicators but after 25yrs I can tell you that the indicators have been wrong many many many times. HOW-WHY? Because the market is constantly changing and there is no way anyone can foresee the unknowns; look at what happened with oil prices - 911 - COVID. No one could have obviously predicted it and it affected everything. Bank of Canada - you can get whip lash with how quickly one release can change from another. They aren't being dishonest, it CHANGES. They decision rates 8 times a year. The point is, if BANK OF CANADA can't give a consistent answer because things are constantly changing, then how can an advisor give you one?
SO HOW DO I DECIDE?
Your own instinct is probably already guiding you to one, and you have more education on it now which is all you needed (on top of a good advisor - pick me pick me). Some of the best advice I ever received was from an RVP at the bank I used to work at, she said “I never regret or feel bad about decisions I’ve made in the past. All you can do is make the best decision with the information you have at the time.” She was the toughest, most direct lady I have ever know. People actually hid when she came into the branch (and before I was a manager and couldn't, I HID TOO.). But she was brilliant, and she was right. You can go into a variable and the rates move quicker than you thought. You can go into a fixed and the darn rates go down after. There is interest rate risk inherit with both products. So that RVP's advice to me, is my advice to you.
I CAN ALWAYS "PORT" TO A DIFFERENT HOUSE RIGHT - INSTEAD OF PAYING A PENALTY?
When it works for a client it can be a good thing, but NEVER be talked into a rate/term because they say “you can port it”. WHY? It doesn’t work for most because you can’t put your amortization back to 25yrs. If you had only 15yrs left on your existing home/amortization and you port – 15yrs is the max amortization on the new home. That can make for a hefty new payment if you are upgrading homes, and makes it much harder to qualify. Anyone who tells you "you can just port it" without explaining the info and details around it, they either don't know better or your best interests aren't at the forefront. This isn't a tv, this is our largest asset and debt, you need a professional.
BOTH can be and are good products. I love the set payment and rate on fixed mortgages, but the potential penalty makes me...sick. These IRD penalties will only get worse if rates continue to rise, there is a way to offset some of this risk that Nikole will review with you.
On the other hand, I love the rate and cheap penalty on the variable, but am not a big fan of my payment changing (let me be clear, I would like it when it HOLDS or goes DOWN, just UP I don't want lol).
You will find your own balance in the differences and if you need to talk it out, I'm here.
Free PDF at the bottom with more detail on these 2 products.
Thanks for reading, I'm always happy to answer any questions.
Nikole Krupka Rolof
Edmonton Mortgage Broker