Whether you’re buying a home or looking to renew your mortgage, you’ll need to choose between a fixed or variable rate mortgage. That choice has become more difficult lately as the spread narrows between fixed and variable rates.
Ever since prime rate bottomed out at 2.25% back in April 2009 most of us predicted interest rates would return to historical levels as the economy recovered.
Indeed, by September 2010 prime rate inched up 75 basis points to 3%. But we haven’t had a rate increase since, and, with the global economy sputtering along, it doesn’t look like that will change anytime soon.
Interest Rates Expected To Rise: But When?
When I wrote 20 simple steps to improve your finances back in December 2010, my first ‘step’ was to switch to a variable interest rate mortgage.
The first comment agreed with the list, but echoed what many others were saying about mortgage rates at the time:
“Interest rates in Canada are due to rise with most experts believing they will go up 1-2% over the next year. Locking into a 5-year fixed term now is the smarter way to go.”
I believe that you’ll save money when you take either the 5-year closed variable rate mortgage, or the 1-year fixed rate mortgage, whichever is cheaper.
We bought a new house in August, 2011 and I put my money where my mouth is by taking out a 5-year closed variable rate at 2.2%.
Best mortgage rates
Okay, so that’s great for me but what if you’re looking for a mortgage today? Here’s a chart that compares the best mortgage rates in the country as of April 12th, 2013:
*Source: LowestRates.ca – Compare mortgage rates in Canada
The difference between most 5-year fixed rates and 5-year variable rates is less than 0.5%. Interest rates are so low that it’s hard to go wrong with any of these terms, but you’ll want to look beyond the rate and consider all the features you’ll need with a mortgage.
BMO’s controversial 2.99% ‘no-frills’ mortgage came with a few restrictions, like a limit to how much you can pre-pay or increase your monthly payments.
There are fully featured mortgage products available at these rates, so it’s best to do your research.
Fixed or Variable Rate Mortgage?
I stand my belief that you’ll save money with the better of the 5-year variable rate or the 1-year fixed rate mortgage. Today, that means taking the 1-year fixed rate.
You’ll pay $7,039 in interest at 2.39% for one year on a $300,000 mortgage. Compare that to the 5-year fixed at 2.79% and you’ll pay interest of $8,216 in the first year. That’s nearly $1,200 in savings!
Then, when it’s time to renew in a year, you can take another 1-year fixed or watch for a really good discount off the 5-year variable rate (prime minus 0.75% or better).
Banks and brokers are always screaming for you to ‘lock in’ now before rates go up. That’s because banks make more money on 5-year fixed rates and they use the fear of rising rates to scare you into locking in to a longer term.
Related: Why I Don’t Use A Mortgage Broker
Do you think your bank would be lending you money at 3% for five years if they thought they’d have to borrow at a higher rate in a few years? The banks are rarely on the losing side of a deal.
In Moshe Milevsky’s popular study, “Mortgage Financing: Floating Your Way To Prosperity”, it’s noted that:
“Canadians who can accurately predict the next move of the Bank of Canada – and decide to “lock in” their mortgage when the short rate is about to increase – are worse off on average, compared to those who float over the entire interest rate cycle.
This is due to the fact that in order to properly time the mortgage “lock in” market one requires an ability to predict movements on both short and long term points on the yield curve, which is a skill that even the Governor of the Bank of Canada is unlikely to possess.”
What do you think? Should you get a fixed or variable rate mortgage today?