Is it Crazy to Consider a Variable Rate in Today's Market?
When considering a mortgage, one of the biggest decisions you will make is whether to go for a fixed or variable rate. A variable rate mortgage can offer flexibility and potentially lower interest rates, but also carries the risk of interest rate increases.
You may think in today’s times with higher interest rates than we’ve seen over the past couple years that you would be crazy to take the variable interest rate route, but what if I told you weren’t?
We are going to dive into the benefits of a variable rate mortgage and paint a little picture that may sway how you think. Our objective is to educate homeowners/buyers with ALL the benefits so they can make an educated decision.
Potential for lower interest rates
One of the main advantages of a variable rate mortgage is that you likely end up paying less interest over the course of your mortgage when interest rates are down. This is because your mortgage rate is tied to the prime rate, which can fluctuate based on factors such as the Bank of Canada's overnight rate, inflation, and economic growth. If the prime rate decreases, your mortgage rate will decrease, which means you could end up paying less interest. This can save you thousands of dollars in interest charges over the life of your mortgage. It’s important to keep in mind that we may be at the peak of Bank of Canada rate increases. Many of us are hoping to see a downward trend in variable rates over the next year or so.
A variable rate mortgage can offer more flexibility than a fixed rate mortgage. With a fixed rate mortgage, you're locked into a specific interest rate and payment amount for the entire term of your mortgage, which can make it difficult to make changes if your financial situation changes. With a variable rate mortgage, your payment amount can change if your interest rate changes, which can give you more flexibility to adjust your budget if needed. This can be particularly important if you are self-employed, have a variable income or if your job is in a field where salaries are less predictable.
Option to lock in your rate
Although a variable rate mortgage is subject to fluctuations in the market, most lenders will allow you to switch to a fixed rate mortgage at any point during your term. This can be particularly appealing if interest rates are low and you want to lock in that rate for the remainder of your mortgage. This way, you can enjoy the flexibility of a variable rate mortgage while still having the option to switch to a fixed rate if necessary.
Lower penalties for breaking your mortgage
Breaking a mortgage before the end of its term can result in penalties, which can be significant. With a variable rate mortgage, the penalty for breaking your mortgage early is typically three months of interest, whereas with a fixed rate mortgage, it can be much higher. This can be particularly important if you anticipate needing to sell your home or refinance in the near future.
We have explored the general benefits to a fixed rate mortgage, but wanted to show a scenario with today’s rates and industry numbers. Currently fixed rates are generally lower than the variable rate on mortgages today in Canada. For example;
Fixed with a 5 year term = Monthly Payment - $2147
Variable Monthly Payment - $2355
With this scenario there are two important things to note. 1. With a fixed rate you are locked into the rate for the entire term. Your payment is $2147/month for 5 years. 2. The variable rate is currently over $200 more a month, however, as prime fluctuates over the 5 years, so does your mortgage payment.
If prime was to head south in the range of pre pandemic numbers, your monthly payment would be $1962, which would be saving you money each month.
*Above numbers are hypothetical and for illustrative purposes only. This is not a commitment to lend, pre-approval or approval.
In conclusion, a variable rate mortgage can be a great choice for those who value flexibility, have a risk tolerance and the potential for lower interest rates, However, it's important to remember that a variable rate mortgage is subject to fluctuations in the market, which can lead to higher payments if interest rates increase. It's important to consult with a mortgage professional to determine if a variable rate mortgage is right for you and to understand the risks and benefits associated with this type of mortgage.