Variable Rate Mortgage Strategy
Many borrowers know and understand and consequently use, variable rate mortgages today than ever before.
Dr. Milevski of York University, Toronto, performed a study that reported that between 1950 and 2000, having a variable rate mortgage proved to be less expensive than the traditional five year fixed term strategy 88% of the time.
Anyone who obtains a variable rate mortgage should realize that there is a risk involved because of the uncertainty of the rate. But for all of these last years, it has been shown to be a good risk.
The interest rate of a variable rate home loan changes with the base rate of the large Canadian banks. The lender does not give you a fixed rate, but rather a rabais on the base rate. This is why variable rates are expressed as a base rate less a percentage.
If the base rate, for example, is 6.00%, and the bank quotes base rate minus .90%, this means that the variable rate loan will be 5.10% for the length of time that this base rate is in effect. If the base rate is lowered by the Bank of Canada, the loan rate is likewise lowered: a new base rate of 5.25% will mean a variable mortgage rate of 4.35% for that period. The Bank of Canada adjusts this rate 8 times per year. Note that this rate may be refixed at the same rate (no change), so the base rate does not necessarily have to change 8 times per year.
– It has been shown by studies to be the best strategy, especially in stable or falling interest rate environments.
– A borrower can take full advantage of periods of lowering interest rates.
– Mortgage payments are usually lower in the case of variable rate mortgages.
– This option is available with a lot of lenders.
– Many lenders offer this loan option.
– The rates are variable, so they can go either up or down, adding a risk factor.
– Your mortgage payment amount may change up to 8 times a year. (There are ways to avoid this, however-read below.)
– You have to follow the interest rates of the Bank of Canada several times a year.
When is it good to use this strategy on the long term?
The variable rate strategy has been the best choice over time, as studies have shown. This has been the case in falling or stable interest rate environments, but it is important to keep track of interest rate 8 times a year to manage this strategy effectively.
All of the variable rate mortgage products offer the option to convert to a fixed rate. However, there are certain lenders (mortgage brokers can identify them) who increase the fixed rate when a client is converting from variable to fixed.
This is easy to explain. When a borrower decides to convert, it is because the interest rates have increased. If there is no provision in the original engagement letter, the lender can give the client a high fixed rate for the fixed rate loan. This would be the highest posted rate, or the rate with a rabais. This is not the best rate that can usually be obtained. The client has to decide whether it is better to stay with the variable rate, or opt for the higher fixed rate.
There are lenders who are able to promise in the engagement letter that the best fixed rate option will be offered to the borrower. We only work with lenders who are willing to offer this promise to our clients. As you can see, it is very important to pick the right lender for your mortgage loan.
Is it possible not to have varying payments?
Many people prefer not to have their mortgage payment change over time, since it makes managing their funds difficult. There are solutions to this:
Some lenders fix the payment and do not change it when the rate changes (in this case, it is the amortization that changes).
You can increase your payments from the beginning so that they are at the level of the mortgage payment you would have on a fixed rate mortgage, which is normally higher. In this way, if the rate increases or decreases, your payments will probably remain the same. I prefer this solution.
How to stay current on changes on the mortgage interest rate
The rate on a variable rate mortgage changes with the base rate of the Bank of Canada. It is not difficult to follow this.
This base rate can change a maximum of 8 times per year, so it is not as if you have to keep track each day. It only happens when the Bank of Canada changes its directeur rate. This is an important news item that is announced in the newspapers, on the radio and on T.V. and on internet news.
In addition, we offer to our clients (free of charge) an email subscription service that allows them to follow the change in the base rate each time the Bank of Canada meets. In this way, our clients know the change in the interest rate the same day it occurs, and they also receive predictions for the coming months
Option: Variable rate with a ceiling
Certain lenders offer a variable rate with a ceiling. That is to say, if the variable rate increases to more than the ceiling, your mortgage will be adjusted so that your rate will be equal to the ceiling. In other words, the ceiling rate is the maximum rate for your mortgage.
The variable rate strategy is an excellent strategy and should be considered by all borrowers. It can save a borrower thousands of dollars in interest rate costs. But you should follow this advice:
1. Be sure you choose a good lender; there are many versions of a variable rate mortgage and you want to make sure you get the best one for you.
2. Pay attention to the conversion option and the new fixed you will receive at conversion.
3. Keep track of interest rates or make sure that your mortgage broker stays in contact with you to advise you of changes.
Over the last fifty years, studies have shown that the variable rate mortgage strategy is the one that saves you the most money.