mortagered

Fixed Rate Mortgage or Variable Rate Mortgage?

One of the most common questions I get asked is: “Which is better, a fixed rate mortgage or a variable rate mortgage?”  In my opinion, there is no  “yes” or “no” answer, because there are several things to consider.

What is a Fixed Rate Mortgage?

A Fixed Rate Mortgage (FRM) is one where the rate does not change for the term of the mortgage.  Most clients choose a 5-year rate, which means the rate would remain constant for 5 years.  With the rate being constant, the payments remain the same.  As a guide, today’s FRMs are going for as low as 2.74%.

What is a Variable Rate Mortgage?

A Variable Rate Mortgage (VRM) is one where the rate can vary during the term.  VRMs rely heavily on the Bank of Canada’s prime lending rate. These types of rates can go up or down at any time and are therefore considered variable.  Today’s Prime Lending Rate is 2.85%.  Many lenders are offering a discount of – 0.65%.  This would make your current interest rate 2.20%.  Should the Prime Lending Rate go up, your rate would go up and vice versa if it should go down.

Qualifying for a Variable Rate Mortgage

Most people do not know that anyone applying for a VRM (or any mortgage that is not a 5-year fixed rate) has to qualify using the Bank of Canada’s Benchmark Rate, which is currently 4.79%.  If someone is purchasing, this may affect their purchasing power.  If income is not sufficient to support the mortgage and other outstanding liabilities using the Benchmark Rate, clients do not qualify for a VRM.  So, step 1 is always to determine if the client qualifies for a VRM.  When applying for a 5-year FRM, the discounted rate is used to determine affordability.

For example, if a client earns $50,000 and wants to purchase a home, using the VRM qualification rules, the client could afford a home with a purchase price of $230,000.  However, using the FRM qualification rules, the client could afford a home with a purchase price of $275,000.  This scenario assumes the client has no other monthly liabilities, property taxes are 1% of the purchase price and there are no condo or maintenance fees.  Down payment is 5% of the purchase price.

Determining Risk Tolerance

After the initial process, if it is determined that the client qualifies for a VRM, step 2 is to determine risk tolerance.  If a client says they are not good with risk, then I suggest they proceed with a FRM.  This will allow them to have peace of mind and, very importantly, be able to sleep at night.

If however, the client says they are risk takers, then the client has to decide which option to choose.  As a note, most lenders will allow a client to “lock in” their VRM to a FRM.  Make sure what rate the lender will offer you at this time. Is it their discounted rate or their posted rate?  This is very important to know, considering the posted rate is at least 1% higher than the discounted rate.  If it is the posted rate, again, the client has to decide if they want to proceed.

Should my clients qualify for a variable rate mortgage, I recommend they line up their payments as if they had opted for a FRM.  This allows them to pay more towards principal and to pay off the mortgage quicker.  The important factor is not to exceed the lender’s pre-payment privileges.

Rates are at an all-time low for fixed and variable rate mortgages.  If you would like to discuss your current situation, please do not hesitate to reach out to me at maria@heritagelending.com