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Fixed or variable mortgage? Flip a coin

Fixed or variable mortgage? Flip a coin

When you ask Ranjit Dhaliwal whether now is the time to let a mortgage float at a variable rate or lock it in at a fixed rate you normally get a straight answer.

Like most mortgage brokers he’s been heeding warnings from the Bank of Canada and Federal Finance Minister Jim Flaherty to lock in before record low mortgage rates start rocketing up.

After over two years of those warnings, the sluggish economy has the Bank of Canada backtracking – even suggesting the next move for interest rates is down.

Dhaliwal says deciding right now between a fixed and variable rate mortgage is a toss up.

“It depends on your individual circumstances.”

Variable rate risk

Here’s what he means: with the variable rate at about 2.5 per cent and the five-year fixed rate topping 3 per cent, there’s no question borrowers would have – and will be - paying down a bigger chunk of their principle by sticking with a variable rate mortgage.

But floating rates can change quickly and it’s important to understand the risk variable rate borrowers are taking – especially younger households with low incomes and big mortgages.

As an example, a $300,000 mortgage amortized over 20 years at the current rate of 2.5 per cent would require monthly payments of $1,588.

If that same variable rate rose to 5 per cent, monthly payments would jump to $1,971.

Households on a tight budget could find the nearly $400 monthly increase devastating.

Timing to lock in could be right

Another argument for making the leap from a variable to a fixed rate relates to timing. The two rates are influenced by different forces but seem to be in sync right now.

Variable rates are linked to the prime rate set by the major banks for their best customers. That prime rate is linked to the Bank of Canada trend-setting rate.

The Bank of Canada rate has been frozen at 1 per cent for over three years and most economists expect it to remain frozen for at least a year. The major banks have frozen their prime rates at 3 per cent for nearly as long.

Fixed rate mortgages, on the other hand, track bond rates, which are influenced by the broader bond market. The difference between fixed and variable rates can change drastically. Dhaliwal says at this point in time they are relatively close.

“The spread is very narrow right now” he says, making this an opportunity for homeowners with variable rate mortgages to make the jump to fixed, in the event fixed rates go up ahead of variable rates.

A recent report from Royal Bank of Canada suggests rising bond yields, as a result of the improving economy, could drive fixed rate mortgages higher by later this year.

If that happens, this could be the last opportunity for homeowners with variable rate mortgages to lock into a 5-year fixed rate at 3 per cent.

The sleep-at-night premium

Locking into a fixed rate can sometimes save money in the long term but Dhaliwal says don’t count on it. “Statistically, you will always pay more on the fixed rate mortgages rather than the floating rate mortgage” he says.

However, one factor he says homeowners should consider goes beyond the extra cost of locking in - security.

He suggests homeowners should look at the extra cost of a fixed rate mortgage as an insurance premium that lets you sleep easier at night, knowing you won’t be sideswiped by a sudden rate increase.

His advice is to shop around not only for the best fixed rate but the best term to maturity. He says right now the 5-year closed mortgage gives the biggest bang for the buck.