One of the biggest dilemmas that Canadian homeowners face is whether to go with a fixed or variable mortgage plan. First time home buyers are especially plagued by this decision because of their inexperience with the whole process. Before deciding which type of mortgage works for you it is essential to understand the differences between the two.
A fixed rate mortgage is one that has a set interest rate that will remain constant for a specific period of time. This period of time is normally called the “mortgage term” and varies according to the mortgage. With a fixed mortgage rate you know exactly what your monthly payments are and there are never any surprises. Keep in mind that security comes at a price. Banks normally charge a slight interest rate premium for this peace of mind and many will even charge a hefty penalty fee if you sell your home and choose to break your mortgage. Another downside is that with a fixed rate you are unable to take advantages of any savings when interest rates dip. A variable rate mortgage differs in that the rate does not remain constant but fluctuates with any changes in interest rates. If the interest rates are down one month your monthly payment will be down and vice versa. Unfortunately a variable rate does not offer secure positioning that allows you to have a set payment amount every month. Although it takes a certain tolerance to risk to choose a floating rate it can provide huge savings over the mortgage term. A popular study published by Moshe A. Milevsky in 2001 argues that a variable rate saves money in the long term. This study compared fixed and variable mortgages over a fifty year period from 1950-2000. The conclusion was that a variable mortgage saved Canadians about $22,000 in interest payments over a 15 year $100,000 mortgage by borrowing at a prime rate instead of the five year rate. Mr. Milevsky also concluded that Canadians were better off with a variable rate 88% of the time. It is arguable that the past cannot predict the future and today’s economy is much different than it was fifty years ago. Still, over the last five years most people who have a variable mortgage have saved notable amounts of money.
Choosing what type of mortgage is right for you can be stressful because it can save you thousands of dollars over the mortgage plan. Taking a realistic look at your financial situation should be the first step in determining what type of mortgage is right for you. If you cannot afford to take a hike in your monthly payment then a variable rate is not right for you because it always comes with risks. If you can afford to do so then you may want to think about a variable rate mortgage dependant on the market. Other factors to look at when deciding on your mortgage are portability, prepayment options, tax efficiency, and other customized options that are available.
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