Peter Kinch is an author, speaker, entrepreneur and investor who has been educating Canadian mortgage consumers for over 10 years, and is recognized as one of the foremost Canadian experts in financing real estate portfolios. Here are some of his thoughts these days on Fixed and Variable rates.
With the recent talk of rising interest rates, there is a tendency for those who are currently in a variable-rate mortgage to rush out and lock in to the best five-year rate available today, or a new or first time home buyer, to lean towards the comfort and security that a long term fixed rate provides, especially in times of uncertainty. In fact, there is so much talk about locking in these days, it makes you wonder if maybe that's exactly what the banks want us to think.
The interesting point here is that anyone who has taken the variable-rate mortgage over the fixed-rate mortgage has been further ahead 88% of the time over the last 20 to 30 years.
If you do the math you can separate the truth from the hype.
Ø At the time of writing this, the prime rate was 3% and the best five-year rate mortgage was 4.05%.
Ø A recent report by RBC suggested that prime would go up by 1% by the end of 2011 and they anticipated a further 1.5% increase by the end of 2012. This is in line with what many analysts and economists are predicting.
Ø I'm going to assume that the prime rate in Canada will double to 6% over the next five years.
Ø I then compared a client with a $300,000 mortgage and 25-year amortization who locked in today for a five-year mortgage at 4.05 to a client who chose to float in a variable rate at prime minus 0.60%. The key here though is that I kept the monthly payments the same for both clients and compared where they were at the end of the five years. The results were surprising
Ø The client who chose to stay floating at prime minus 0.60% over the five-year period ended up saving just under $5,000, even though their interest rate at the end of the five-year term was 5.4%.
So what does this tell us? The average interest rate for the variable ended up being around 3.7% over the five-year period. The reason for this is a fundamental key to all mortgages. You pay the bulk of the interest upfront. So what this analysis shows us is that having a lower interest rate in the first few years but choosing to make a higher payment has the effect of accelerating your debt reduction to the point that it is still more economical to remain floating - even if the prime rate were to double.
