The variable mortgage strategy - Hypotheque

Variable Rate Mortgage Strategy

For some years now, variable rate mortgage loans have become more and more popular and more and more used by borrowers.

Dr. Milevski of York University, Toronto, conducted a study that reported that between 1950 and 2000, having a variable rate mortgage proved to be a cheaper strategy than the traditional five year fixed term strategy 88% of the time.

Anyone who obtains a variable rate mortgage should realize that there is an inherent risk because of the uncertainty of the rate. But for all of these last years, it has been shown to be an acceptable risk.

Description

The interest rate on a variable rate mortgage 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.

Example: “Base rate less 0.90%”. In this case, if the base rate is 6.00%, the client will pay 5.10% on his loan (6.00%-.90%) for the period of this base rate. A few months later, if the base rate is 5.25%, the loan rate will be 4.35% (5.25%-.90%) for the period of the new base rate. The Bank of Canada fixes the rate 8 times per year. This does not mean that the rate will necessarily change 8 times per year, but it is possible.

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 mortgage.
- Payments are normally lower.
- There is a lower penalty fee than with other loans.
- Many lenders offer this loan choice.

Disadvantages

- The rates are variable, so they can go either up or down, adding an element of risk.
- Payments can vary with the interest rate. (It is possible not to be subject to variations n your mortgage payment-see 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 has been shown that the variable rate policy is most often the best choice, especially if interest rates remain stable or decrease. But since we can never know for sure if interest rates are headed up or down, you have to keep close track of rate adjustments at least 8 times per year.

You can switch to a fixed rate option when you have a variable rate loan, but you have to be careful about the new fixed rate. Some lenders (your mortgage broker should be familiar with which ones) increase the fixed rate when the conversion option is being chosen.

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 obtained by a mortgage broker. So the client has to decide which makes more sense over the long run, variable or higher fixed.

Certain lenders (all of the ones we recommend to our clients) promise in the loan engagement letter that when the client makes the choice to convert, he will receive the best broker rate for the loan for that day. You have to carefully choose your lender if you are going to use the variable rate strategy.

Can a borrower avoid fluctuating mortgage payments?

The idea that the mortgage payments can increase or decrease with a variable rate mortgage makes a lot of people uncomfortable. There are two solutions:

You can opt to have a fixed payment, no matter if there are changes in the rate. What will happen is that the amortization amount will change instead.

You can raise your initial payments up to the higher level of a fixed rate loan and then any increases in the variable interest rate will be covered. This is the solution I recommend, since you will not be increasing the balance due on the mortgage.

How do you stay on top of the interest rate direction?

Due to the fact that the rate on your mortgage 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.

First of all, the base rate can only change 8 times per year (it’s not every day), that is, when the Bank of Canada adjusts it directeur rate. When the bank changes the rate, this announcement is broadcast throughout the media: newspapers, radio and television).

In addition, we provide for our clients (free of charge) an email subscription service that allows them to follow the change in the base rate each time the Bank of Canada meets. In this way, our clients know the change in the interest rate the same day it occurs, and they also receive predictions for the coming months

Variable rate with Ceiling option

Certain lenders can give a variable rate with a ceiling. That is to say, if the variable rate increases to more than the ceiling, your mortgage will be adjusted so that your rate will be equal to the ceiling. In other words, the ceiling rate is the maximum rate for your mortgage.

Conclusion

The variable rate strategy should be given a lot of thought. It is a strategy that can save a borrower thousands of dollars in interest rate costs. But it is important to keep these three things in mind:

1. It is important to have a good lender, since there are many types of variable loan.
2. Make sure you obtain a conversion option that will guarantee you the best fixed rate at conversion.
3. Stay on top interest rates or make sure that your mortgage broker stays in touch with you to advise you of changes.

The variable rate is the strategy which has performed the best over the last 50 years.

Gregory is an Accredited Mortgage Professional (AMP). To get more information on mortgage rates - taux hypothèque, please visit: Mortgages - hypothèques