A friend of mine asked me if he should get a fixed rate or floating rate mortgage. When we purchased our house about four years ago, we opted for a five-year, fixed-rate mortgage and in the past four years, the variable, below-prime mortgage rate has never been above our fixed rate of 5.25%. The Bank of Canada is now holding interest rates steady and the consensus opinion is that the Bank will cut interest rates in 2007. In our case, we could have saved a bundle on interest costs if we had opted for the variable rate mortgage.
Prof. Moshe Milevsky, a Professor of Finance at York University has done extensive research on this topic and has published an easy-to-read paper titled Mortgage Financing: Floating Your Way to Prosperity. He analyzed interest rate data from 1950 to 2000 and found that Canadians would have been better off borrowing at the prime rate versus the 5-year rate 88.6% of the time.
Prof. Milevsky revisited his original article (Mortgage Financing: Should You Still Float? Four Answers) in 2004 when interest rates were at historical lows and offers this advice:
The decision of whether to go long (fixed) or short (floating) should depend on your tolerance for risk as well as your ability to withstand increases in mortgage payments. You can always expect a financial reward for going with the float, although the precise magnitude will ebb and flow depending on the economic environment.
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10 responses so far ↓
1 0xcc // Oct 12, 2006 at 8:23 am
Did you miss a word in the last sentence of the first paragraph?
” In our case, we could have saved a bundle on interest costs if we had opted for the fixed rate mortgage. ” Should there have been a not before opted?
Last September we fixed about 80% of our mortgage and went for a five year term. After a little bit of negotiating we were able to get a 4.55% interest rate which at the time was about 0.3% higher than the variable rate (and a few days after I locked in the variable rate increased to 4.5%). Now it is 1.45% below the current variable rate so at least in the short term it looks like we made a good move although we could have done a little better if we had locked in around June instead of September. I suspect that by the end of the 5 year term it will have been slightly better to have stayed with a variable rate but I was looking for some shorter term stability (I thought that prime would actually go as high at 7% or 7.25% but it doesn’t look like that will happen) and I plan on being mortgage-free at the end of the term of our current fixed mortgage (in 2010) and I just wanted to guarantee that I would be able to meet that goal and having a non-moving target makes that easier to plan for.
2 Canadian Capitalist // Oct 12, 2006 at 10:17 am
You are right. I meant “variable rate” in that sentence. Thanks.
3 Wealthy Geek // Oct 12, 2006 at 10:50 am
Milevsky really hits the nail on the head. “Going for float” is all about risk tolerance and how tightly wound your monthly budget is. A higher mortgage payment due to a higher interest rate can really be a bull in a china shop if you’re living pay cheque to pay cheque, but over the long haul a floating rate is going to help your net worth. How do you make it easier to tolerate the ebb and flow? Perhaps find ways to create wiggle room in your monthly budget so that you can handle the occasional interest rate hike. Easier said than done, of course.
4 Brock // Oct 12, 2006 at 11:17 am
I just got a closed variable for 5 years for Prime minus .90 Only have a relatively small mortgage left but now I was wishing I got the National All-In-One which is based on Prime and lets me have a home equity line of credit and pay off my mortgage more quickly.
I am going to get pre-approved for it anyways and may pay a penalty next year to go for it but in the mean time, prime minus .90 (adjusted every month) is going to be great for me.
I got my mortgage at prime minus .40 variable (prime minus 1.99 for the first 3 months) first, then changed to prime minus .60 variable and now have prime minus .90 I knocked off 65K of my mortgage in 5 years and that wasn’t even using all of my privilege payments.
I like the idea of All-In-One banking though moving forward. I expect 2 prime rate drops next year as do most pundits.
What do you guys think of Prime minus .90 closed variable? I know Dundee offers Prime minus -1.00 which works out to -.95 APR which is the close to mine (my APR works out to 5.062 right now)
Thoughts?
5 Canadian Capitalist // Oct 12, 2006 at 12:24 pm
Brock: As long as you can handle the risk the prime rate might spike, a variable rate is an excellent choice. Some economists are predicting a 100 bps cut in rates in 2007, so you might come out well ahead of a fixed rate.
6 Alex Givant // Oct 13, 2006 at 11:42 am
When I had variable rate at CIBC (switched to fixed March 2006, cannot stand prime going up) they told me that when prime fluctuate, my monthly pay stay the same - the only division between principal and interest change. Wodnering how it’s done in other places.
7 Steve Heath // Oct 13, 2006 at 2:44 pm
Well, Scotiabank does it the other way, when the rate rises they increase your payment to keep the same amortization period, and last I heard BMO does it that way as well.
8 Bryce // Oct 13, 2006 at 3:18 pm
My BMO mortgage keeps the payments the same when the price increases. I had to call them and increase the payments so the amortization period wouldn’t go up.
9 Bryce // Oct 13, 2006 at 3:18 pm
Sorry, that’s when the interest increases
10 NLG // Dec 17, 2006 at 1:43 pm
Thanks for the info, this is a really good collection of information on the age old VRM vs. fixed debate.
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