I get calls and questions on this topic almost every week. Given the changing market, it’s time for an update as of November 15th, 2009.
In fact, I recently took a call from a real estate lawyer who was buying a place and wanted my opinion on this topic, and I went into great length as to what I thought. In the end, she ended up taking variable, and in this market, I think this is the right move, for her. Here is why:
I have written several strong articles in favour of fixed mortgages in the past. For me, personally, I just like them. Period. It’s the way I work. I want to know what my payment is going to be for the next 5 years and I don’t want anyone telling me otherwise.
Could I save money if I took a variable. Probably, but I don’t care. If you are considering fixed or variable rate mortgages there are three things you need to think about three specific questions:
1. What are the current rate offerings ?
2. What is your income and employment situation?
3. What is the reason you are buying the property?
WHAT ARE THE CURRENT RATE OFFERINGS?
Previously, when I was arguing for fixed rates for most clients it was at a time when the 5 year variable and 5 year fixed were nearly on par. This was because the capital markets were forcing banks to set their variable at prime rate PLUS 1.5% or prime rate PLUS 1.0% for a rates that were equal to (or even higher!) than fixed mortgages. In this situation, with prime rate sitting at all time lows, it made no sense to take a variable rate when there was only one way for rates to go (up) and no savings, even on day one, by taking a variable rate mortgage.
If there is no savings by taking a variable rate, why absorb the risk of the rising payment?
Well, capital markets have changed, and there are a few banks offering prime MINUS 0.10% for a net rate of 2.15% versus my best rate on a 5 year fixed of 3.85%. This is a full 1.7% difference, and this market, that is substantial. In other words, prime rate would have to rise from 2.25% up to 3.95% before you break even. With the Bank of Canada pledging to hold rates low until mid 2010 that is about 9 months of a significant savings before we see prime start to move up. If you want to save some money, this is a compelling time to take a variable rate as you can transfer to a fixed rate mortgage at any time, with no penalty.
Based on current offerings from banks, and depending on your own answers to my next two questions, variable looks like the way to go.
WHAT IS YOUR INCOME AND EMPLOYMENT SITUATION?
With a variable rate, you face a variable payment (or a variable amount that goes towards principle – which CAN result in a negatively amortizing mortgage where you owe more at the end of the term than at the beginning, if you don’t pay attention).
So, how are you paid? How often? Are you paid a salary that is set? Do you get bonuses or commissions? Are you self employed with the option of more work if you want it? These are all important things to think about.
If you are paid a salary, and especially if you need to take a variable rate to comfortably afford the property, you need to be very careful if you take a variable. You’ll need to watch interest rates and lock in at the first sniff of rising rates. This is true unless you have a mortgage payment that is very modest when compared to your salary.
If you get bonuses and commissions, do you NEED to earn those bonuses in order to make your payments? What happens if the rates rise (and your payment) and you don’t get the bonus? Will you be ok? Do you have enough “wiggle room” in your budget to absorb a higher payment, or a higher payment along with lower income?
If you are self employed, how seasoned is your client base? How confident that you can repeat last year’s success? If you are a realtor, chances are you have done very well the last five months, but what about last december through march? If your income is seasonal, or varies dramatically, do you also want a variable payment?
The bottom line is to look hard and dispassionately at your income pattern. If you have a lot of “wiggle room” to absorb a rising payment, or if your budget is sufficiently comfortable, then you can take a variable and enjoy the savings.
However, if you NEED that variable rate to afford your payment, you should not be taking it and not buying the property. People are, by their nature, myopic, and they only look at the recent past. If rates rise, are you going to be ok?
WHAT IS THE REASON YOU ARE BUYING THE PROPERTY?
This is often overlooked. People get so hung up on fixed versus variable discussions that they forget why they are buying the property. If you are buying a rental / investment property, then you likely are thinking all about cash flow. If this is the case, variable may be the way to go. If you are buying your own home, and you intend to live in it for a while (5+ years, for example) then you may want a fixed rate so you can rest assured your housing payment won’t increase.
Or maybe not.
There are lots of other reasons, and here are a few: Maybe you’d prefer to buy your house and you want to save every penny, so you plan on taking variable and watching rates like a hawk to try and capture the most savings possible. Personally, as someone IN the industry, I think this is madness unless you happen to enjoy watching interest rate and bond moves (perversely, I do, and you should take advantage of this).
Or maybe not.
Maybe you are buying a property that is a “holding property” and you simply want to minimize your carrying costs until you subdivide it, or until the subdivision or city plan reaches your property and you sell. Variable might be a good choice here as your exit plan is relatively assured and timeline clear. With savings available on variable in the short term, this might be the way to go.
Or maybe not.
Maybe you have a lot of “wiggle room” in your budget, but are so busy you don’t feel like watching rates all the time, and heck, if rates rise a point or two it won’t be the end of your financial world. Variable might be the way to go here.
Or maybe not.
Maybe you are doing an equity take out to invest, and with rates so low you want to lock in now at the fixed rates because you don’t believe they’ll be back any time soon. You plan on investing the money, and you want to know what your “cost of capital” is so you can monitor if your investments are outperforming your debt to buy them. In this case, fixed rates are likely for you.
Or maybe not…
As you can see, a lot of the decision is very personal, and based entirely on features of your own unique financial situation and personality makeup.
There is no rule of thumb. Brokers that drone on and on that “variable is always best” are likely getting angry calls from their clients they put in variable mortgages 6 months ago when rates were prime + 1% and are now Prime – 0.10%. Good. That’s the way it should be. Advice is only as good as the person giving it, and if they don’t take the time to look at your unique situation of income, risk tolerance, budget, and property type, then they aren’t doing their job and you should be speaking to someone like me instead.
Until next time, happy house hunting!