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Mortgage Rates: Fixed or Floating

October 11th, 2006 ·

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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17 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.

  • 11 Les // Oct 22, 2008 at 12:32 pm

    I just realized that TD bank’s mortgage prime of 4.75 is different than the regular Prime rate posted at 4%, why is this??? I hold a variable mortgage which is 0.95 below Prime, which I thought to be 3.05, when in fact it is currently 3.8%.
    Did I miss something when I signed up?

  • 12 J public // Oct 28, 2008 at 2:10 am

    Les, sounds like a scam, bank prime is indeed 4% right now. And, this makes your rate 3.05 as you say.

  • 13 Gus // Nov 3, 2008 at 2:50 pm

    My mortage is with ING and I have prime minus 0.75% since July 2008 on a 5 year term with rates adjusted every 3 months.

    I got my first adjustment today (nov 2008) and now prime being 4% my rate for the next 3 months will be 3.25%.

    ING adjusts your monthly payment automatically in order to keep the same amortization period (unless you’re already at maximum amortization rate which means you HAVE to increase your payment)

    My new payment is now $200 less but I choose to call in and have the payment increased back so that in effect I’m making a $200 principal repayment for the next 3 months.

    Had I opted for fixed rate back in July, I would still be paying 5.25%. if my payment dropped $200 from a 0.75% drop, that meant I would have pay approx. $533 more each month with a 2% difference between my current variable rate and what would have been my fixed rate!

  • 14 soon to renew // Nov 19, 2008 at 11:38 pm

    I just found a very “interesting” site. bankofcanada.ca where it lists prime rates since 1935. match the rates with history class and it looks like we may be seeing the same rates Bank of Canada prime 1935-1944 = 2.5% or possibly the 1945-1950 = 1.5% an ecomony very in debt from an overseas war, trying to (re)start an auto industry .

    Right now prime is 4% but I think I’ll wait and see if Detroit gets the $25B to keep it alive. My guess Bank of Canada will move closer to the current American 1%.

  • 15 R from Montreal // Jan 23, 2009 at 10:10 am

    Bank of Canada just dropped the prime rate again this week from 3.50% to 3.00%. With everything going on nowadays, I am guessing this trend will continue for a while. Therefore, I would think it is a great time to have a variable rate mortgage.

    Does anybody know what economists are predicting for 2009, at a minimum?

  • 16 Bucking the conventional wisdom on a fixed-rate mortgage — Canadian Capitalist // Apr 5, 2009 at 6:00 pm

    [...] 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 [...]

  • 17 Melody // May 14, 2009 at 8:26 am

    Now that the variable rate is the lowest it will probably EVER be (2.9%) is it better to start a new mortgage with variable or take advantage of the low fixed rates as well (3.84%). Realizing of course that at this point the variable can only go up?

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