The mortgage renewal is coming up soon for both the house and condo (rental property). Three years ago we chose a 3 year fixed rate mortgage for both – the condo was a great rate (2.10%) and the house was at a higher (but still competitive) 2.60%.
Interest rates at the time were fairly low and since then they have gone down even further. Prime rate back in 2012 was 3.0% and is now at a super-low 2.70%.
Variable rate mortgages have become even more attractive with the drop in interest rates. Discounts of 70 basis points off the prime lending rate means that variable rate mortgages are now below 2.0%.
Historically variable rate mortgages have been less expensive than fixed rate mortgages. I knew this when deciding between fixed and variable (for the current renewal) but I wanted to see how much money I could save on my mortgage. Over 5 years I’d be able to save about $15,000 on a variable rate mortgage (compared to a 5 year fixed rate). That’s a big enough savings for me to choose a variable rate but there were a few other factors involved I wanted to consider.
The nice thing about a variable rate mortgage is that the penalty will be 3 months interest. This works out to about $1,600 in my case, which I consider pretty reasonable overall.
Related: How to Reduce Your Mortgage Penalty
When searching for the lowest rates online I noticed that there are even lower rates available but they typically come with large penalties. The biggest penalty I came across was 2.50% of the outstanding balance – in my case this would be about $8,000. If I went with a fixed rate I’d face a similar sized penalty which doesn’t seem too attractive.
We don’t have any plans to sell or move in the future but it would be nice to have the flexibility to do so if something comes up. Five years is a long time and a lot can change, so the flexibility of having a significantly lower mortgage penalty means we could sell without having a large penalty to pay.
Locking in at a Fixed Rate
The main drawback of a variable rate mortgage is that the interest rate can change often depending on changes in the prime rate. If the prime rate goes up then the interest costs will go up. This is something that doesn’t affect a fixed rate mortgage and it means less stability in the mortgage rate.
With a variable rate mortgage I’d be able to lock in a fixed rate at any time (preferably before rates go up). This seems ideal because it means I could enjoy a low variable rate and then lock in a fixed rate if I thought rates were going to increase. The problem is that if I decided to lock in a fixed rate (from a variable rate) I likely wouldn’t have access to the lowest rates on the market.
For this reason some would choose a fixed rate rather than a variable rate. But even if rates do increase up to 0.50% the interest savings would still be worth it to go with a variable rate (in my case).
Buying Within Your Budget
One of the biggest advantages of buying a home within your budget is that you have the flexibility of going for a lower rate even if it means it may increase in the future.
That’s the situation we are in now and if rates increase we’d still be able to make ends meet. Looking at the monthly budget I realized we’d be able to handle a 40% increase in the monthly mortgage payments. For someone who bought on the higher end of their budget they wouldn’t have this flexibility and would likely opt for the stability of a fixed rate mortgage.
One of the biggest benefits of buying within your means is that it gives you flexibility in your finances – lower mortgage payments means more money to save, invest, pay down any high interest consumer debt or simply put towards the mortgage principal.
Conclusion: I chose a variable rate mortgage over fixed rate because it was the best fit for us. The interest rates are lower, the penalty will be low which means we could break it if we had to and even if rates do increase we’d still be fine.
Do you prefer a fixed rate or variable rate mortgage?