Variable vs Fixed Mortgage
Over the past few years, the differences between Variable vs Fixed Mortgage has shrunk considerably. The obvious benefit of the variable loan is that it comes with a significantly lower interest rate, at least initially. The fixed rate loans have higher interest rates, but they stay at the same rate for the entire term of the loan. Different borrowers choose different products on the basis of their own needs, which is the wisest way to pursue this financial decision. Your own tolerance for risk, personal lifestyle and household income will help you determine the right type of loan for your own needs.
The first thing to consider is balancing the risk of a variable loan against the reward of lower monthly payments while the rates stay low. While you generally have a period of time when the rate stays the same, once that period ends, the rate can go up and down. There is generally a cap for the amount of maximum change, but you are still at the whim of the market. Doing a mortgage payment calculation at different interest rates is the best way to determine whether or not you can handle increases to your interest rate.
This begins with taking a look at your present income as well as any possibility of increased earnings, perhaps in the form of a raise at your current job or taking on multiple positions. If you can afford a mortgage rate that is between two and three percent above the current rate, then you might be able to get through that first term. However, the historically low rates that are the state of the current mortgage market are not likely to stay the same, and they could easily double during the life of a three-year or five-year adjustable rate mortgage.
Once you’ve determined whether your budget can handle a change in your payment, you then need to figure out if you can handle the stress of an adjustable rate. Some people are fine with the possibility of change once they have figured out whether or not they can afford the rate. Others, though, won’t be able to sleep at night knowing that it is possible for their rate to go up. Whichever personality you match is also something to consider. After all, you don’t want to feel stress as a result of the house that you have purchased.
Variable rate vs Fixed rate mortgage loan
One way to avoid the stress is to figure out what the fixed rate payment would be for the same term. So if you are taking out a five year variable loan, the fixed loan interest rate for a five year term would be significantly higher. If you choose an open loan, you can make a higher payment and allocate the difference to principal. This means that you’re already taking on the higher payments that you might face in the future, so if they actually do go up, your budget won’t feel a hit. In the meantime, you’re eating up principal with the excess from your current payments, meaning that you’ll have less of a loan at renewal.
With this in mind, especially given the limit on mortgage term limits in Canada, it might seem like a no-brainer to take the variable loan. However, while past practice was to value variable rates with prime minus, in 2014 they are prime plus, which means that the interest rate difference between fixed and variable rate loans is not as significant as it used to be. The five year fixed rate loan has long been one of the most popular mortgage products, and with the smaller spread (the gap between fixed and variable), for some getting that rate security is the smarter choice. Also, if you are purchasing a home that will need a lot of maintenance, having a fixed rate in place helps you budget for those repairs. If you are about to start a family, you are heading to a lot of other unplanned expenses that could make having a fixed house payment attractive as well.
If you have questions about your own situation, contact one of our specialists at Amansad Financial. We have worked with many clients and helped them choose the type of loan that worked best for their personal situations. Get in touch with us today!