The Mortgage Question

The Financialist • Issue 107 • October 2010

BY ETHAN ASTANEH  BComm CFP

 With recent rate increases by the Bank of Canada and likely more to come on the horizon, the age-old question of whether to go with a fixed or variable rate mortgage is worth revisiting. A variable rate mortgage charges interest based on a formula linked to the prime rate, which is influenced by the Bank of Canada rate. When the Bank of Canada announces changes to its bank rate, the prime rate follows suit, causing banks and credit unions to adjust their formulas for lending at the variable rate to reflect their cost of borrowing.

Some variable-rate mortgages increase the monthly payment every time the Bank of Canada hikes rates, while others keep the payments level and change the mix of interest and principal repayment (either way, the total cost to the borrower increases). The recently popular variable rates did much to help Canadians buy more property with more debt in a decreasing rate environment, but perhaps the changing interest rate landscape warrants a change in strategy.

The alternative is a fixed-rate mortgage, which comes at a premium to the variable option in exchange for the peace of mind of locked-in interest costs. In this mortgage structure, the payments of interest and principal remain constant (during the term – not the amortization period – of the mortgage) irrespective of what might be a changing interest rate climate, thus providing a level of protection.

The prevailing fixed rates at any given time are not directly driven by the Bank of Canada rate in the same way their variable counterparts are. Instead, fixed rates are steered more (but not exclusively) by the happenings of the government bond market.

Statistics from Invis-Feisal & Associates Mortgage Consulting in Cloverdale, a mortgage brokerage company, suggest that 88 per cent of the time a variable mortgage is cheaper than a fixed mortgage, but the tide may be turning.

Mortgage rule changes effective April of this year make it easier for borrowers to qualify for a fixed five-year term. Also, at the time of writing, the spread between Government of Canada bonds and fixed mortgage rates is large enough to allow financial institutions to reduce fixed rates, with room to spare.

Although fixed mortgages typically come in five year terms, the risk-averse can consider a longer contract. A benefit of doing so involves a century-old law: the prepayment penalty for any mortgage longer than five years is limited to three months’ interest on the portion of the term that extends beyond five years, as opposed to the greater of three months’ interest and the interest differential. (The interest differential is the difference between the interest on the mortgage to be paid and the amount the banks could earn by re-lending your principal owing.)

So what decision is right for you? A good starting point is to paint a clear picture of your cash flow position. Those running a tight budget who don’t foresee a pay raise in the near future will need the consistency of a fixed mortgage to prevent interruptions in cash flow. On the flip side, if you feel secure in your income, have some wiggle room in your budget, and don’t require the certainty of fixed payments, you may want to let it ride and see how far the variable rate wave can take you.

It is also important to stay in tune with your appetite for risk. If you generally avoid risk or know that the consequences of variable rates will keep you up at night, locking in a fixed rate for a term and forgetting about it may suit you best.

Furthermore, having the right team of professionals behind you is critical. Working with your financial advisor and mortgage specialist will help by keeping you up-to-date on economic trends, mortgage rates, and other useful information.

If you would like to be connected with a mortgage specialist or want to have a general discussion regarding your mortgage, please contact your Rogers Group Financial advisor.