January 26, 2009
Is a Variable Rate Mortgage the way to go?
Wow, the Bank of Canada has once again lowered its prime rate by .5%, but unlike the last time prime was lowered, most of the mainstream banks have jumped on board and lowered their lending rate as well.
Speaking to people on the street you hear a buzz because they expect mortgage rates to plummet as well. Fixed rates have certainly dropped and you can currently get a 5 year fixed rate at 4.49%, which is down from 6.19% just a few months ago. The buzz is not about the fixed rates though, but about the variable rates which the public erroneously believe to be substantially lower than that.
In the past the banks had actually been discounting their variable rate so that if you were lucky enough to sign for a mortgage last year, you are probably paying as little a 2% interest currently.
As it turns out the banks, at least for the time being, have stopped the practice of discounting prime and have been setting their variable rate at anywhere from prime plus .60% to prime plus 1%. Now the much anticipated lower variable rate is not so much lower.
The cost of an average mortgage
Let us take a closer look at a typical scenario. The average mortgage of approximately $ 250000.00 amortized over a twenty-five year period with a five year fixed term at 4.49% will require a payment of about $1382.00 per month. The payment per month with today’s variable rate of 4% given the same amortization period would be $1315.00, a savings of $67.00 per month. If everything remains the same, that would translate into a total savings of over $4000.00 at the end of a five year term.
Things however, do not remain the same, hence the name variable rate. This past year alone, the prime rate has been on a virtual roller coaster ride, giving many people cause to wonder if it is prudent to go with a variable rate at all.
Don’t just squeeze by
Buying a house is probably the largest and most important purchase you will make in a lifetime. You should not go into this transaction quickly, or with your eyes closed. The buyer should be acutely aware of what their repayment capabilities are, and they should never make a purchase that will allow them to just squeak by on their monthly payments. No one knows what tomorrow will bring, whether it’s an unforeseen expense, a downturn in the economy, or a loss of a job.
Those of you who don’t heed my advice would most definitely benefit from a fixed rate because you don’t have to worry that next month your mortgage payment will be so much higher. On the other hand those of you who are more prudent and leave yourselves a little breathing space will most certainly be able to benefit from a variable rate. Those of you with raised eyebrows right about now are questioning the wisdom of going with an unstable rate, because as I pointed out earlier, there has been a huge fluctuation of the prime rate over the past year.
Statistically I can point out to you that over the term of any twenty-five year amortization period, it has been proven that a home owner will always save moneywith the variable rate. If by some fluke the variable mortgage rate begins a scary ascent most banks will allow you to switch your variable rate to a fixed and less stressful rate.
A word of caution when choosing a lending institution, is to make sure that the rate that they will fix your new mortgage at, will be a discounted rate and not their high posted rates.
My advice to you when choosing a mortgage is to seek out a competent Mortgage Broker to help you through this process. A bank can only offer you whatever programs they have available, but a Mortgage Broker can show you the best program from a multitude of lending institutions.