Morgage Strategy - Variable Mortgage strategy (hypotheque)
By: Gregory van Duyse | Posted: 23rd July 2007
Variable Rate Mortgage Strategy
More and more borrowers know and understand and consequently use, variable rate mortgages today than ever before.
A report by Dr. Milevski (York University, Toronto) indicates that between 1950 and 2000, variable rates were cheaper than the 5 by 5 strategy (five years fixed) 88% of the time.
It is clear that this strategy, merely by its variable nature, infers a risk, but over the last years, excellent results have been achieved by assuming this risk.
Description
The interest rate on a variable rate home loan is based on the base rate of the large Canadian banks. The borrower will pay a rabais over this base rate. A variable rate loan is always quoted as the base rate less some kind of percentage.
If the base rate, for example, is 6.00%, and the bank quotes “base rate minus .90%”, this means that the variable rate loan will be 5.10% for the period that this base rate is in effect. If the base rate is lowered by the Bank of Canada, the loan rate is likewise lowered: a new base rate of 5.25% will mean a variable mortgage rate of 4.35% for that period. The Bank of Canada fixes this rate 8 times per year. Note that this rate may be refixed at the same rate (no change), so the base rate does not necessarily have to change 8 times a year.
Advantages
- The variable ratestrategy has been the best choice over recent years, especially in the periods of falling or unchanging interest rates.
- It permits one to take advantage of falling rates during the period of the loan.
- Penalty fees on variable rate mortgages are typically lower than on other types of mortgages.
- There is a lower penalty fee than with other strategies.
- Many lenders offer this loan choice.
Disadvantages
- This loan has the risk of your mortgage interest rate going up.
- Your mortgage payment amount may be adjusted up to 8 times a year. (There are ways to avoid this, however-read below.)
- You have to follow the interest rates of the Bank of Canada several times a year.
When to Use this Strategy for the Long Term
It seems clear that the variable rate is often the best choice, especially when interest rates are trending downward or are stable. Since it is difficult to know for sure if rates are going to increase or decrease, if you take a variable rate, you have to watch the direction of interest rates 8 times per year.
All of the variable rate loan products offer the option to convert to a fixed rate. However, there are certain lenders (mortgage brokers know who they are) who increase the fixed rate when a client is converting from variable to fixed.
The explanation for this is simple. Obviously, when a client wants to convert, it is because the interest rates have increased. If the bank has not put any proviso for the conversion rate in the original engagement letter, they can give the client the highest fixed rate, such as the posted rate or the rate with a rabais. This is not the best rate that usually can be secured by a mortgage broker. So the client has to decide which makes more sense over the long run, variable or higher fixed.
There are lenders who are able to promise in the engagement letter that the best fixed rate option will be offered to the borrower. We only work with lenders who are willing to offer this promise to our clients. As you can see, it is very important to pick the right lender for your mortgage loan.
Is it possible not to have varying payments?
Many people prefer not to have their mortgage payment change over time, since it makes budgeting difficult. There are solutions to this:
Some lenders fix the payment and do not change it when the rate changes (in this case, it is the amortization that changes).
You can pay more initially to bring your payments up to the level of a fixed rate mortgage and this will allow for any changes that may occur if the mortgage rate increases. This is the solution I recommend.
How to stay current on changes on the mortgage interest rate
Due to the fact that the rate on your home loan will vary with the base rate, it is important to keep an eye on the base rate. It is not very difficult to do this.
The base rate can change up to 8 times per year, so it is not a number that has to be tracked constantly. It changes when the Bank of Canada changes its directeur rate. This is information that is considered important business news, and is therefore announced in the newpapers, on radio and on T.V.
We offer a service to our clients, gratis, whereby they receive email notification whenever there has been a meeting of the Bank of Canada and if the rate has increased, decreased or stayed the same. We also include predictions about the upcoming scenario for interest rates.
Variable rate with Ceiling option
It is possible to get a mortgage with a variable rate that has a cap on the rate. With this type of mortgage, if the rate keeps increasing, once the cap rate is hit, it cannot increase any further. The ceiling rate or cap rate on the loan becomes the highest rate your loan can have.
Conclusion
The variable rate strategy is a valuable strategy and should be considered by all borrowers. It can save a homeowner thousands of dollars in interest rate costs. But you should follow this advice:
1. It is important to have a good lender, since there are many variations to a variable loan.
2. Pay attention to the conversion option and the rate you will receive at conversion.
3. Make sure you know what is going on with interest rates, or that you have a mortgage broker who is committed to keeping his clients informed.
The last half century has shown that the variable rate home loan strategy can be the one that saves the borrower the most money.
Gregory is an Accredited Mortgage Professional (AMP). To get more information on mortgage rates - taux hypothèque, please visit: Mortgages - hypothèques
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