It is now widely-known that homeowners can save money by opting for a variable-rate mortgage over a fixed-rate mortgage in the vast majority of instances. Ben, an astute observer of financial matters, recently grappled with the question with his own mortgage and decided that with potential high inflation in the future and low spreads between fixed-rate and variable-rate, this might be one of those rare occasions when it makes sense to go fixed. According to Invis, a mortgage broker, fixed-rate mortgages can currently be had for 3.99% over 5 years compared to variable at 3.30% (Prime + 0.80%).

Should you go with a fixed-rate mortgage (FRM) or a variable-rate mortgage (VRM)? One thing is clear about questions of this nature: nothing is ever clear. In the same way that RRSP vs. mortgage vs. TFSA can never be answered definitively for all cases, the decision on whether to take a variable or fixed mortgage interest rate can also never be resolved in cookie-cutter fashion.

To paint broad strokes, banks charge a premium on FRM’s to accept the risk that money will not be so cheap in years to come – by accepting a VRM, and hence the risk, you stand to save money, historically, and on average.

Widely-reported Dr. Moshe Milevsky of York University authored a study in 2001, with a subsequent update summarized nicely here, where 90.1% of the time over 1950-2007 it was better to have chosen a VRM over a FRM (down to 77.1% if you have good negotiation skills and credit, and can secure a discounted rate). As discussed in the comments there, it would be nice to know what conditions existed in those minority of times when it was better to have a FRM, ie. historically, given that prime rate was x%, what was the probability that fixed would fare better than variable over the next finite time period?

Given that mortgage interest rates are currently at an all time low, one has to wonder whether historical studies have the same relevance when brought to bear on current market conditions. The spread between VRM and FRM is extremely slender at the moment – on a standard 5-year term closed mortgage, the best discounted VRM today is just north of 3% and the best discounted FRM is about 4%. The narrower this gap, the better one’s probability of doing better with a FRM.

Some have argued that when rates do begin to go up, as they almost certainly will in time, the increases will be modest at first and at that point early in the rise one can lock in to a fixed rate. However, it is a certainty that by the time the average Joe realizes it’s time to lock into a fixed rate, the banks will have raised the fixed rate higher than he could have gotten today. This becomes a case of pay less today on your VRM, pay more tomorrow on your FRM.

In a recent discussion, Dr. Milevsky states generally that people with a lot of assets and therefore increased ability to deal with risk should still consider a VRM. Dr. Milevsky offers that those with small home equity, or low or unstable income, may want to consider a FRM.

Historical studies aside, there are some elephants in the room these days. Job stability is at generational lows, house prices are in steady decline, the future of North American automakers hangs in the balance, and governments are pumping trillions into the financial system with uncertain results. These are uncharted waters.

Ultimately with mortgage rate choices, as with all other aspects of personal finance, it comes down to risk management. If we pull out all the stops in efforts to maximize the slice of pie at retirement, we run the risk of burning the pie, or finding we’ve arrived at the dinner table without a plate and fork. If we don’t take the occasional calculated risk, however, we may find that there’s not enough pie to eat on Tuesdays.

And as always, more important than the decision you make on VRM vs. FRM is the decision you make in your day-to-day life to control your expenses, increase your income, and direct the net savings toward paying off the mortgage and maximizing registered and non-registered investments.

[Update: You may want to check out this post on Canadian Mortgage Trends on the same topic.]

This article has 63 comments

  1. With those historical studies I always wonder it it takes into account amortization period and people making additional payments to pay down their mortgage quicker?

    • Canadian Capitalist

      mfd: I don’t think making additional payments should make a difference. If anything, it would show that VRMs are much better because a homeowner can opt to keep the payments the same as a FRM and paydown the mortgage a lot faster.

  2. I guess I was looking at it from a perspective of “market timing” with your mortgage. I figure if you lock in now to a 10 year mortgage and then pay off a large portion if not all of it before the term was up you could come ahead of a VRM. Then again rates may not go as high as people think over the course of 10 years and VRM could be the winner in the end.

    Good post CC.

  3. I agree with you CC. I think being a contrarian is a good thing.

    The conventional wisdom from late 1990s is that stocks are a better investment than bonds from books like Stocks for the Long Run. We know that really wasn’t the case unless you are good with market timing,

    The conventional wisdom in Canada for mortgages is that VRM is better than FRM based on studies like the one quoted above. When everyone thinks something is good, it might not be good anymore.

    Being a contrarian, go for the FRM unless you can time the mortgage market when interest rate rises. The longest mortgages available in Canada is 10 year mortgages. If one can lock in a cheap 10 yr FRM, that would be really good.

  4. Peace of mind is very important — and easy to overlook if you’re focused on the dollars.

    In 1994, we took a 10 year mortgage because we didn’t want any surprises (one income, child on the way). We expected to use prepayment options to pay down what we could. Other times, we’ve had 6 month mortgages and variable rate mortgages.

  5. [Sort of US centric] I wonder if QE on mortgages will last long enough that the Fed will end up subsidizing your house for 5 or 10 years.

    Certainly Japan has had zero rates for well over a decade.

  6. I agree that it is hard to “time your mortgage”, but I have been extremely happy with our VRM. We are 3 years into a 5 year VRM and we are currently paying 1.65% (Prime – 0.85). I’m not looking forward to renewing/re-negotiating our mortgage in 2 years because I know we won’t get anything close to this again. Personally, if I’m comfortable with the monthly payments of the FRM rates in 2 years I may opt for a 10 year FRM and hope to pay off the rest of the mortgage in this time. Otherwise, we may take our chances with another 5 year VRM and see what happens. At any rate, the easiest thing to decide right now is to NOT accelerate our mortgage payments – this is the cheapest loan ever, and I can get more value by just dumping the money into a high-interest savings account.

  7. @Leah. That is probably the predominant way of looking at the world during periods of low interest rates. However, the OTHER view would be that if you accelerate your mortgage payments during periods of low interest rates, that accelerates your build-up of home equity as you would be paying down more of your principal and have less of your monthly payments eaten up by covering your interest.

    My own personal philosophy would be to use your cash to pay down your mortgage in order to build up your home equity. And then get a secured homeowner’s line of credit from your bank set up just in case you may need some cash in the future for whatever reason. Where I bank, they will allow a secured line of credit up to 70% of whatever amount of equity that you have in your home, so the more of the principal amount that you’ve paid, then the larger the line of credit that you are eligible to receive. And if you choose to use that line of credit for investing, such as I have done, then you get both a lower interest rate (as compared to an unsecured line of credit) and a tax deduction for the interest paid for the leveraged investing. From a pure taxation standpoint, this is more tax efficient than not paying your mortgage and investing your cash.

    Remember that interest on home mortgages are NOT tax deductible in Canada whereas interest on leverage to invest for an income IS tax deductible. Of course, you shouldn’t invest solely for taxation purposes, but it is definitely an option for you to consider. The government created our odd tax code for a reason and the way that it is structured, that is basically what they are telling us taxpayers that they would prefer that we do by providing us with the tax reduction incentives to do so.

  8. I should disclose that I’m currently completely mortgage free, but I still maintain my homeowner’s line of credit for use in leveraged investing from time to time.

  9. Leah: Had I been a bit wiser some years ago when I first took a mortgage, I might be smiling myself to have a prime -0.8% mortgage! Those days of prime minus seem to be gone, at least for the time being. Surprised that you are able to come out ahead in a high-interest savings account these days – with the average high-interest savings account around 1.75% these days, that’s equivalent to about 1.2% assuming 31% marginal tax bracket, less than the 1.65% on your VRM. You would have to be earning about 2.5% in the high interest savings account to put it on par with paying off your mortgage.

    While I understand the principle of using cheap money to invest in a higher-return forum, for now I tend to use a keep-it-simple approach in my own financial life. I prefer to look at today’s low interest rates as a great opportunity to reduce principle today, shelter principle from higher interest rates in future, and increase financial flexibility in years to come.

  10. @ Econstudent – isn’t contrarian investing based on going against “conventional wisdom” vis-a-vis current crowd behavior?

    It’s difficult to see how the contrarian view is applicable to the FRM v. VRM debate, given that Dr. Milevski’s research is backwards looking. Given that future rates are unknown, and it’s always difficult (at best) and impossible (at worst) to time the market, wouldn’t it be smarter to go with what decades of market history have shown? Spreads are smaller than in past periods, but it should be relatively easy to adjust for that within the model – just adjust the historical variable rates to historical posted rates minus the current spread.

    I don’t necessarily disagree that FRMs are looking attractive at this point, but I’m not sure that is has anything to do with the conventional wisdom of my neighbours.

    Would also point out that a majority of people still opt for FRMs, and did even before the economic downturn narrowed spreads. A contrarian would therefore choose a VRM.

  11. Agree with Al R, FRM is not contrarian. Most of my friends who have recently bought a house have opted for FRM despite the past performance of VRM.

    I’m in an identical position to Leah – Prime-.85 – and it’s been great (right now). But unlike her I’m putting any extra money towards the principle in anticipation of much higher interest coming. Similarly, I have about 2,5 years left before renewal and I am a little concerned how high interest rates will go, and have thought about going to a FRM.

  12. At any rate, the easiest thing to decide right now is to NOT accelerate our mortgage payments – this is the cheapest loan ever, and I can get more value by just dumping the money into a high-interest savings account.

    I’d like to see your calculations on this. I’m pretty skeptical that any high-interest savings accounts actually make you more money in the long run than putting the extra onto your mortgage. Remember, when you pay off principle, you don’t just save interest on that money for the current billing cycle, you also save all of the down-the-line interest.

    Personally, like Phil, I’d be more inclined to pay down extra now, when more of your money is going directly to principal than interest, rather than pre-pay when interest rates are high.

  13. I am in the same boat as Leah, prime-.85 expiring in less than 2 years.
    This posting is timely as to trying and figure out what to do in 2011, but who knows where BoC rate will be and bond rates, or in general the economy!

  14. Canadian Capitalist

    I remember reading somewhere that the vast majority of mortgages are FRM. If I recall correctly, VRMs accounted for 30% of mortgages; only a minority of homeowners opt for VRMs.

    When we first got a mortgage, we went with fixed back in 2003 because the situation was similar to today: heavy job losses in the tech sector where we both worked… economic uncertainty etc. So we went with a FRM for peace of mind; although in hindsight, a VRM would have saved us a bundle of money.

    Though our mortgage rate was low (5.3%), after maxing out our RRSP contributions, every bit extra was put towards the mortgage. I did regret it somewhat in 2006 and 2007 but now with stocks back at 2003 levels, it looks like a great move! There is something to be said for a fairly attractive, guaranteed, after-tax rate of return obtainable by pre-paying the mortgage.

  15. Some lenders are now allowing you to structure your mortgage with both a fixed rate and variable rate portion (obviously any HELOC does this).

    We’ve got two properties, so we’ll likely renegotiate one at a fixed rate and the other at the variable rate to offer some reduced interest rate risk, but even if you only have one property, its doable, and in my eyes, one of the better options over either going ‘all in’ to a fixed or variable rate.

  16. I am in a similar position to Leah. I have a Prime – 0.95% rate, and pay accelerated bi-weekly. I deliberately decided to overpay when I set up the mortgage, factoring in approx .5% increases in Prime, meaning that
    1 – I would be cushioned from rate increases to the tune of .5%
    2 – I am overpaying and eating into the principal

    I subsequently found out that I am overpaying the minimum amount by around $650 each month. The effect on the principal is outstanding! This calendar year alone, I have eaten away at close to $3k.

    However, I am closely following the market and will lock in when rates start to climb to make sure that I am living within my means, and most inportantly, the affordability factor is taken into consideration.

  17. Al R & Mat H: I don’t have a house and do not pay mortgage. My source of information for mortgages come from online discussion, articles, and ads. I had the impression that most people uses a VRM. Obviously, that is not a case. Thanks for telling me that.

  18. I’ve got concerns about inflation in the next 2-3 years, so I’m in the process of finding a 5 yr fixed under 4%. I have an amazing VRM right now at prime -.85% and am paying down huge amounts of principal, but I will also switch that to a long term FRM when its up in 1.5 years.

    If I can get all my mortgages into sub-4% FRM’s and inflation kicks off as I expect, the cost of my money remains static nominal terms and declines in real terms, while my rental income increases with inflation. I love it!

  19. Voice_of Reason

    This topic is very interesting to me. I am currently shopping for a mortgage to buy my first home.

    Typicall thinking is that you can go variable for now while the rates are low with the intention of locking in when the rates go up. The problem is, it’s not that easy. When prime goes up, FRMs have gone up long before. This is what bankers get paid to do. You can’t outsmart the system. You basically have to take a chance that locking in at a 5yr FRM now at 4% now will hopefully save you some dough in 4 years where prime is back up to 5-7%. If the recession is as bad as some poeple are forecasting, then obviously VRM is the better way to go, as rates will stay low for quite some time (see Japan). So you’d tend to lose out on the FRM.

    I don’t think anybody has the right answer when it comes to FRM and VRM.

  20. No disrespect to the report cited, but you don’t need to be a rocket scientist to know that going from sky high rates 21% in the early 80’s, to virtually nil real rates now that locking in will have – in hindsight – been more expensive than variable. I hope he didn’t spend a bunch of time anlyzing that, because it is not that difficult to determine.

    Had rates moved the other way, the report would have suggested exactly the opposite. CC has the right idea wondering what the circumstances were that made the fixed the right choice.

    But now rates are virtually nil in real terms (after inflation) – and the possibility of inflation being quite large in the not-too-distant future makes 5 year at 3.99% an absolute lock in my opinion.

    Time will tell, but I’ll be amazed if inflation isn’t more than 4%/yr over the next 5 years.

    If anyone thinks we can’t possibly return to a time with 10% mortgage rates (like in the ealry 90’s), you’re dreaming. I remember doing a jig down the street when I got 8.375% in 1994. I couldn’t believe it. Doesn’t take too much inflation for lenders to demand a premium.

    Under the current interest rate scenario, you can be a little right going variable, but you could be a lot wrong. Alternatively, you could be a little wrong going fixed, but very right.

    So I say (rather rudely for effect) “Don’t be stupid – go fixed at 3.99% if you can get it….and try to save money elsewhere.”

  21. Returns Reaper

    I don’t think a small VRM/FRM spread should be used to as an indicator that an FRM may be a good idea.

    I think of a VRM as the most basic form of a mortgage where the homeowner bears future insurance rate risk. I view a FRM as insurance. You pay extra, but you’ll never have to pay more than the fixed rate. The amount extra you pay is dependent on future interest rates.

    Banks are in the business of lending to make money. If they are going to bear the interest rate risk instead of the homeowner, they want to be paid for it. So I think they use the expertise of their employees to set the spread such that they are very likely to make money off of a FRM relative to a VRM, based on where they think interest rates are going to go. No one can accurately predict this, but I would think they make the spread larger than they think it needs to be to make it very likely the bank will come out ahead on the FRM.

    While I am also very concerned of future inflation and interest hikes that would occur as a result of the free-flowing economic stimulus we’re seeing around the world today, I believe that to bet on FRM is to bet against the collective wisdom of the teams of economists that work for the banks that try to predict future interest rates. While no one seems to have a particular knack for predicting the future, I also believe that they are more likely to be right than I am.

    And the data in the cited study shows that the banks are right about 90% of the time. If there are certain historic conditions that tilts things in the favour of homeowners, remember the banks also have this information. Wouldn’t they account for this and increase the VRM/FRM spread?

    In any case, my opinion is to continue on with VRM unless you are near the edge of being able to afford your house. And if that’s the case, jump on an FRM soon. If you wait for inflation to set in, banks will have already priced this into their models and FRM rates will be much higher than they are now.

    Do you have to be able to tolerate rates in the 20+% range like we had in the 80’s? I don’t think so. People are far more leveraged now than they were back then (avg. cost of a house today as a percentage of average income is higher, also down payments are typically smaller as a percentage). So many homeowners would be forced to foreclose at those rates that they economy would hit a serious recession, forcing rates down. I’d suggest that if you’re able to tolerate substantially higher rates than a majority of homeowners would be able to, then you’re relatively safe — before interest rates hit your breaking point, the economy should have cooled enough to prevent further rate hikes.

    The trick here is knowing what interest rates other people can afford relative to you. I have a feeling I’m in good shape, but I don’t have any real data. Does anyone have any good suggestions for what data could be used to determine what the average mortgage holder would be able to tolerate? That is a tough question as it would depend on their willingness and/or ability to adjust their standard of living as interest rate pressure crept up.

  22. The debate of FRM vs. VRM has become quite difficult since the banks no longer offer variable rates below prime. I am currently paying 0.85% below prime which offers a greater spread versus a fixed rate, however if I was to take out a new VRM I would be looking at prime plus 0.80%. The rate spread between VRMs and FRMs hardly seems worth it any longer. I love (sarcastically) how prime rate is at an all time low yet the banks burn us on the lending spread.

  23. Return Reapers: I believe banks use different sources of funding for FRM and VRM.

    VRM is funded by short term saving accounts and money market. Saving accounts nowadays offer something between 1.25% to 1.75%. CC says that banks are offering 3.3% VRM. The spread is how much the bank can make.

    A 5 yr FRM is funded by something comparable to a 5 yr GIC. A 5 yr GIC from a major bank is offering 2.2% (You probably can get a .5% bonus). That is a decent spread from 3.99% FRM.

    Therefore, I don’t think the banks are betting on interest rate when they are offering you the choice of VRM or FRM.

  24. I have to agree with Reaper that the banks have some expertise in setting the FRM rates and these rates definitely include a premium for the bank taking this risk. Why would the bank put its profit margin at risk.

    From a straight economic perspective, VRM makes more sense and an FRM is just a gamble that the bank has not properly set their FRM rate. What does regular joe-schmo really know about predicting future interest rates? Does he know more than the big banks? An FRM is a gamble against a more experience player.

    However, the FRM and VRM decision is largely made on emotional grounds rather than purely economic. People prefer the stability of an FRM (does this preference allow banks to charge a higher premium for FRM?).

  25. Canadian Capitalist

    Reaper: I believe banks don’t have full control the spread between VRM and FRM. VRM is based on the Prime rate which is linked to the interest rates set by the Bank of Canada. FRM is based on 5-year bond rates. Banks don’t have any control over either the BoC rate or the 5-year bond rate.

    What banks do have some control over is the spread on Prime (for VRMs) and 5-year bond rates (for FRM). But even that control may not be all the much due to competitive pressures.

    The reason FRM – VRM is low at the moment is because the spread of the VRM over the BoC rate is very wide at the moment. It may be a quirk that may not last very long, which is why at this moment a FRM might be a better deal.

  26. Returns Reaper

    @EconStudent, CC: Good point about the banks not bearing the risk directly and/or FRM rates based on 5-year bond rates rather than a VRM/FRM spread. However, I still think the 5-year bond rates price in the risk of interest rate changes. Collectively I’d expect this to do a better job of pricing interest risk than a bank’s own team of economists.

    However, your point about the reason for the tight VRM/FRM spread being more due to banks increasing the VRM/BoC spread rather than the market’s collective wisdom (indirectly through the bond market) on future interest rates is well taken. It’s certainly food for thought.

    As someone who has a “good ol’ days” P – 0.95% mortgage with 3 years left in the term, I think I’d be tempted to stick with it and decide based on market conditions in 3 years whether FRM rates are still favourable vs. VRM rates. But then I am running the risk that perhaps inflation has already taken hold and it’s too late to get a good FRM rate.

    One other thought that just came to mind is if banks are increasing the VRM/BoC rate spread, this is presumably to increase profits on VRM mortgages. Wouldn’t they want to increase profits and increase FRM/5-year bond spreads to increase profits on FRM mortgages as well? If so, the FRM/VRM spread is still proportional to the BoC/5-year bond spread, which is still has all of the wisdom of the market with regards to future interest rates over the 5 year period.

    • Canadian Capitalist

      @Reaper: I don’t know why the FRM/bond spread looks steady compared to the VRM/BoC rate spread. I took a cursory look at the FRM spread over 5-year rates at the Canadian Mortgage Trends blog and it looks fairly steady. The VRM/BoC rate spread, though, has widened significantly. Like you point out, it used to be quite easy to get Prime – 0.9% mortgages and now the best seems to be Prime + 0.80%. That’s a 1.7% swing and if you add in the 0.25% increase in the spread of Prime over the BoC rate, we are looking at a 2% increase in the spread of VRMs.

      I do agree with you that the 5-year rate reflects the market’s collective wisdom and the market is usually right. The way I look at it is the 60 basis points FRM/VRM spread seems to be a very small price to pay for locking in a low rate. Of course, the VRM may still turn out to be better deal but the cost of being wrong here is much lower than it used to be in the past.

  27. As CC and Rob point out, the cost of being wrong on a fixed rate gamble is very low today. The cost of being wrong on a variable rate gamble could be higher. At the end of the day (and it is the end of the day…!), it’s an expected value calculation either way – probability of event multiplied by cost/benefit of event occuring. Unfortunately, we can’t actually compute this at the moment without a crystal ball, but I’ve rolled my dice on the fixed rate based on my own risk profile.

    Had I the good fortune to have renewed in early fall (or foresight to pay the break fee and re-negotiated) before the VRM swung from P-x to P+x, I would almost certainly have signed the P-x VRM.

    I picture 2 ropes swinging like pendulums in a non-repeating pattern, one VRM and one FRM, with you the indebted mortgager swinging on one or the other. From time to time, the two ropes will swing close enough for you to pull a Tarzan act, and switch to the other rope, where Jane is perched for the moment. This gap between the ropes represents the spread between FRM and VRM (and Jane represents more money in your pocket). To me, it seems like a good time to switch ropes.

    As concluded in the post, what should be emphasized above all is that this is a game of risk management. Whether one is likely to win or lose by following either course is only part of the decision; equally, or more, important is job security, size of your mortgage, current real estate market, one vs. two incomes, diversification of those incomes, employment prospects in your field and geography, and life phase, etc.

  28. Ben: Have you compared between a 5yr and 10yr FRM? When does it justify to take a 10yr FRM if one is concerned about inflation?

  29. I’d like to hear about people’s experience locking-into a FRM from a VRM.

    My lender will only allow me to lock-in from my closed Prime-0.6 VRM (currently 1.9%) to a FRM at posted (i.e., non-discounted) rate, which is currently 5.35%. That seems like too much of a price to pay . . .

    Are others able to lock-in at the discounted rates?

  30. Returns Reaper

    @CC: Thanks for digging and comparing VRM/BoC spread vs. FRM/5-yr bond spread. The fact that aren’t moving in tandem surprises me, but it is an excellent data point to back up the notion that perhaps now is the time for FRM, especially if you’re due to renegotiate.

    I would think for people who have a P-x VRM mortgage, unless their own risk profile has changed or they feel strongly that inflation is going to take hold soon and interest rates will skyrocket, switching now wouldn’t seem to make a lot of sense to me — especially if there is a penalty that must be paid to make the switch.

    This has been a great topic for a post and there’s been some great discussion!

  31. Returns Reaper

    I just had a theory on why it might be that VRM/BoC spread is rising much more than the FRM/bond spread. Whether or not the theory holds any water depends on whether my stab in the dark at how FRMs are actually funded. I’m assuming that the bank essentially issues a bond at a fixed interest rate to match the maturity date of the FRM. Whether this be with GIC-like deposits as EconStudent suggests or actually a bond the outcome is that the bank owes an income stream to someone for the duration of the FRM term.

    So what would happen if interest rates dropped substantially such that VRMs were much more attractive than the FRMs everyone was locked into? Everyone might be inclined to pay a penalty to break the FRM and enter into a VRM instead. The problem is, the bank is still on the hook for all of the bond-like income streams.

    So what’s a bank to do? If they start narrowing the VRM/FRM spread (by raising the VRM/BoC spread) there is less incentive for people to refinance from an FRM to a VRM. Also, the extra profit they’re making on the VRM mortgages can help pay for the fixed maturity obligations tied to the dissolved FRM mortgages.

    As I mentioned earlier, I’m not too familiar with the details of how banks actually fund FRMs, but could this theory explain what we’re seeing? If so, what we’re seeing would be driven by a recent trend for everyone to flee from FRMs to VRMs. If so, FRMs could essentially be considered to be “on sale” relative to VRMs at the moment. The banks would be looking for someone provide an income stream to meet their existing fixed term commitments and part of the FRM insurance is being subsidized by those entering into VRM terms with large spreads?

  32. Returns Reaper: I don’t think it is that complicated.

    Short term funding like money market and saving accounts fund VRMs. One of the reason why new VRMs are prime +1% is to balance out those old VRMs – 1%. I think it is as simple as that and there is no conspiracy theory on part of the bank.

    The reason why I think that FRM are funded by GICs is that if the bank want to issue a 5yr bond right now, it has to pay around 5% interest rate. On the other hand, 5yr GICs are between 2.2% to 2.7%.

  33. EconStudent: The best and most straightforward answer I’ve seen to the question on term length and associated interest rate is embedded in one of the links in the post, in the section titled “Comparing Short and Long Terms”.

    Returns Reaper #32: I would tend to agree with your comment that people with P-x VRM’s should probably stay put. And I would further add – “What a great opportunity to reduce the principle!”

  34. Returns Reaper

    @EconStudent: In my previous post, I was assuming that whatever the form of financing for FRMs, that it was bond-like (GICs are bond-like in that the bank owes a certain percentage of capital as an income stream until the term is up). So if the bank matches bond-like obligations to match their outstanding FRMs, and people with FRMs start switching to VRMs, then how does the bank cover the higher rate FRM obligations? So I wasn’t suggesting any kind of conspiracy on the part of the banks but rather just simple supply and demand. The bank might have plenty of FRM obligations to cover so maybe they’re discouraging VRMs or charging a premium to help cover obligations tied to dissolved FRMs.

    @Ben: I agree it’s a great time to pay down principal. The more I pay down in the time I have left in my VRM, the less sensitive I’ll be to interest rates when I have to renew.

  35. @ Ted
    I have my Prime – 0.95% with Firstline (part of CIBC) which I arranged via a mortgage broker. I was investigating the possibility of increasing the mortgage or borrowing against it, but I was told that if I did that, my rate would be adjusted to Prime. I forget if that would be for the remainder of the term (about 2.5 years) or start again with a 5 year term.

  36. VRM all the way.

    MAX it out and wait for the VRM bailout package in 2015.

  37. Common Misconceptions:

    1. Mortgage rates are tied to BoC prime rate. Not true. We have become used to them moving in sync because banks were competing for your mortgage business. In the future as banks struggle to correct their losses the spread can be whatever they choose. As it was in the past.
    2. Mortgage rates change slowly enough for you to move out of your VRM into a FRM. Historically mortgage rates are very volatile. However the public has ceased to recognize this because in recent history the volatility is all to the downside. Many of you are probably not adequately pricing in your VRM risks.

    Currently we are at the bottom of the interest rate cycle, and the BoC has openly announced they intend to begin using ‘quantitative easing’ now that they have dropped interest rates to near zero. ‘quantitative easing’ is the new fangled word for ‘printing money’, which always leads to inflation. Inflation means higher interest rates.

    If there has every been a time to move to a FRM, it is today. Interest rates have no where to go but up.


  38. @Kirk – 100% concur that interest rates have no where to go but up, but the multi trillion dollar question is, “When?”

    Answers on a crystal ball, please 🙂

    Coming from the UK, I keep an eye on the UK press. When quantitative easing was first raised, the papers were all over the implications of printing money. I haven’t seen the same reaction over here in the mainstream press (G&M, etc) which is somewhat worrying.

  39. I am a Mortgage Broker and alot of these posts i agree with, some i do not. For the most part, a VRM is a great way to attack principle, in any case. However, the lucky ones were people how took VRM’s about a year ago, you probably secured a 5 year VRM for a P -.85%, in that area. So your having a good ride. Unfortunately, the good days are over, and 5 year VRM run at about P+ .80%. The spread between VRM and FRM is drastically dropping. I am offering clients 5 year fixed money at 3.75%, so if your risk sensitive, fix it up.

    Another huge thing that gets over looked is the bank is there to make money. Know what your option to fix is, if you are in a VRM. Typically, if you have a VRM with an option to lock up, the option is usually POSTED less 1 percent. Posted is often at least 1% higher than a discounted rate. Today, for instance, 5 year posted is 5.45%, and like i siaid, my discounted is 3.75%. YOu will not get the benefit of locking into the discounted products, not unless you would like to incrue penalties. All in All, different strokes for different fokes.

    If anybody has a VRM that is maturing in the next 12 months or so, you will benefit by fixing. Speak to a mortgage broker, a high producing one. He or she will assess your situation, and will be able to beat any rate quoted by your “trusted” bank.

    Thanks for you time.

  40. @six pack…hahahahaha

    @Kirk, well put. We saw the BoC drop for about 2 months without our FRM’s budging. We are at an all time 43 year low here people, if you have a VRM, i hope you had a good ride. To get the best disccounted FRM rate, you’ll either need to hammer your bank for a good while, or seek out a good mortgage broker..

    Great site CC

  41. We are at a time where frm makes more sense than vrm. There is very little upside potential to the vrm (BOC might go .25 lower, maybe), and lots of downside (2014, what do you think prime will be? probably a lot higher than 0.5!) Guesstimate the rate for each of the next 5 years for a VRM, compare to FRM. I have a hard time seeing any projections that show weighted over 5 years, VRM will be lower than current rate on FRM.

    Currently, I am locking in for 5 yrs at 3.85. VRM would be 3.3 (banks are now prime plus .8, none of that delicious prime minus anymore). Do I think VRM would be higher than 3.85 for a good chunk of next 5 years? I have absolutely no doubt. 2 bank rate increases, and that’s done.

  42. @drebo, well put. 3.85 for a 5 year FRM is a good deal. And if you feel the need to prepay some principal, most lenders offer a 20% prepay priveledge.

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  50. As a first time buyer over 5 years ago, I also was aware of the stats between Variable being statisitcally lower than a fixed. I decided to play the numbers and took the variable. My rate was prime – 0.5% for the 5 yr term. For about 2 yrs, I was below the rate of the best fixed rate I was offerred at the time (4.99%). Then, for about a year and a half, I was probably paying 0.5% above my fixed offer. Then October, 2008 happened. So, not too long after I was back down to 2% or so. Luckily, when I renewed, the Prime +0.8% days had dwindled back to prime +.02 or 0.1, I forget. I am confident I will be in that 2% range for a year, maybe year and a half. The only thing that influenced, my decision, was could I handle the payment at 4-5% if it went up.

  51. As many have said here, it all depends on your financial situation and, more importantly, your state of mind when it comes to all matters financial. If you want to take risks with money management (smart money management with some risk taking might yield good results), then you would go with the variable rates. But if you just want to be able to know with certainty your mortgage amount, then go for the fixed rate.

  52. Smart Money - Fail Math

    My bank is currently offering Prime -.3% in March 2010 for a VRM. My question is at what level of discount is a VRM better than a FRM? or what % difference between the two is one more of an advantage than the other? and let’s say there is a 2% difference does it mean that if the VRM rate only goes up 2% over the course I will be ahead of the game?

    My thinking is we are closely tied to the U.S. economy and if their rebound is slower ours will at also be slowed and inflation will be modest. Granted rates will go up soon but, how fast? how high? I believe fast is not possible given what the economy just endured. So the question remains if pay an accelerated VRM for the time being will my principal be lower at the end of my cycle opposed to the FRM?

  53. Risk Control:
    We should all make a holistic and comprehensive evaluation of our personal risk and reward. Examine your spouse, job, health, real estate, equities, bonds, etc
    If, for example, your investments are very conservative and your job quite secure than why not opt for a VMR in order to strike your appropriate risk/reward balance.
    My point is see the forest not just the trees.

  54. okay here’s my two cents worth folks im up for renewal and have just nagotiated a rate 5yr variable1.75 persent or if i want a five yr fixed at 4.49 still quite a gap between fixed and variable here i believe i have a little lee way here apparently i was only interesed in variable and five yr fixed but i made it absulutly apparent to them that when lock in from a variable i get the whosale discounted rate at that time and written into the contract i kinda believe this the way the market is heading as we head out of ressesion and the bank of canada is going to make there move i believe coming up in june and just to make this firm i do not believe the boc will raise rates in fast mode far from it will be slow process i don’t care what the ecconmists are thinking we have to remember manufactering sector is reallt taking a hit on the high dollar and don’t forget our niegbours to the south how dependent our canada is with them i believe it will be a slow process a lot of people heve put themselves in a debt load over these enormously low interest rates but i may be wrong i think a variable is the way to go if you want to work on that princibal at least should i say the say the short to medium term and betting that the bond markets stay put for the short to medium term -i have given enough interest to the banks maybe i can pay a little less at least fot the short to mediun term here i have not completly decided yet put i think im going variable although i wish my mtge was up a year ago that would have been just great congradulations to all that did .

  55. Compare has some thoughts on the fixed vs variable Interest Only Mortgage.

  56. The are pros and cons for both loan types. Obviously the variable interest rate carried more risk. There is no right or wrong answer since every homeowner has a different financial background and a different tolerance for risk.

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  59. Margaret A. Bolin

    Choosing between a fixed or variable rate mortgage is not a simple decision. You can choose to go with a stable, fixed rate mortgage. Or, you may feel more
    comfortable with the risks and potential rewards of a variable rate mortgage. And due to this confusion people often go to the mortgage agents for advice. The main advantage of selecting a mortgage with a fixed interest rate is that you can depend on an interest rate that stays the same during the term of the mortgage. The down side is that you can’t take advantage of a lower interest rate.
    But in the case of variable mortgage while there is always a risk of interest rate fluctuations, this concern may be less of a factor than you may think, and there are other reasons to consider a variable rate mortgage. Also when rates go down, an increased
    amount of your payment goes to pay the principal. With more going into your principal, the less interest you pay, and the faster the mortgage is paid off.

  60. Hindsightis20/20

    Fascinating that I found this article and then realized the date it was published. Fast forward 5 years later and the interest rate has not budged one bit. So all the people who read this article and went for a fixed rate are probably pissed off and kicking themselves now because they would have saved significant amounts of money on interest on a variable rate.

    My take on it is if you have a good income, always do variable – on top of the lump sum payments you can do yearly, the amount of interest you save will probably more than outweigh the rate at which the rate will go up (if it ever starts going up).