This advice is provided to LynnValleyLife readers courtesy of Mortgage Dave, a local mortgage expert and busy volunteer in our community.
One of the most important decisions when choosing a mortgage is whether to lock in a fixed interest rate or select a variable (floating) rate. With interest rates at historical lows, making the wrong decision could cost you thousands. Let’s look at the difference between the two types of rates, and how this choice might affect you.
With a fixed rate mortgage you “lock in” a predetermined interest rate for a set period of time (i.e., term). The most popular term these days is five years.
A fixed mortgage rate can give you a bit more comfort and security knowing exactly what your payments will be each month for the duration of your term. This makes financial planning and budgeting relatively easy.
The downside of a fixed rate is that if interest rates remain stable or fall during the term you will end up with higher payments than you’d experience with a variable rate mortgage.
Another consideration is that if you need to get out of a fixed rate mortgage before the term is up, you may have to pay a higher penalty. The penalty is typically the greater of either 1) three months’ interest, or 2) the interest rate differential (the difference between your fixed rate and the current market rate multiplied by the outstanding principal further multiplied by the remaining years of the term). Different banks calculate these penalties differently, so I would work with you to ensure the bank you choose matches your needs.
The payments on a variable rate mortgage fluctuate, based on the prime rate throughout the term that you have the mortgage.
Lenders offer the variable rate as a discount off the prime rate. Today the prime rate is at 3% and discounts on variables are around 0.40%, so a homeowner choosing this option will pay about 2.6%. However, your mortgage rate, and therefore your payments, will increase and decrease along with the prime rate. A great feature of a variable rate mortgage is that you can pay it off early with only a three-month interest penalty. The lenders cannot charge the dreaded interest rate differential on variable rate mortgages.
Since the prime rate can increase or decrease on a monthly basis, variable rates are not for the faint of heart. Anyone taking on a variable mortgage needs to be able to handle changes to their monthly payments not only financially, but psychologically as well. If the thought of paying an extra $200 per month in mortgage payments causes you to lose sleep, a variable rate may not be for you. I would work with you to manage this risk.
Then And Now
In the past there has been a huge discrepancy between fixed and variable rates. Five years ago fixed rates were around 4.8% and prime was around 4%. We had large discounts off prime of around 0.9% so you could get 3.1% variable vs. 4.8% fixed. Going with a variable rate was an easy choice for most people, especially if they thought that interest rates were moving downward in the coming years.
Today the best five-year fixed rate is around 2.89% and variables are around 2.6%, so the gap has reduced significantly. Prime has been around 3% for over 2 ½ years and most experts believe it will remain steady for some time, but that it will go up eventually.
Which Is Best For You?
If you are planning on moving in less than five years, a variable may be the best way to go. If you are staying put I would definitely look at a five-year fixed or even a 10-year fixed at a slightly higher rate. On 10-year terms the penalty to pay out after the fifth anniversary is only three months interest, so you get the best of both worlds — stability over a decade and the ability to renegotiate or payout in the last five years for a relatively low penalty.
Everyone’s situation is unique to them, and Mortgage Dave is here to provide a mortgage solution that is customized to meet your specific needs.
As always, I would be happy to review your personal situation and make my recommendations for you. Feel free to call me at 604-315-DAVE (3283) or email me at [email protected].