Variable rates have long been a favourite option for mortgage nerds. In part, that’s because of a 2001 study showing that Canadian mortgage holders would have been better off almost 90 per cent of the time with a variable rather than fixed rates between 1950 and 2000.
Authored by Moshe Milevsky, professor of finance at York University’s Schulich School of Business, the paper compared the cost of borrowing at the fluctuating prime rate vs. five-year fixed rates. It calculated that Canadians would have saved around $22,000 in interest payments on average on a $100,000 mortgage to be paid off within 15 years.
But will floating still save you money now that interest rates seem to be headed up?
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After all, according to Milevsky’s results, the periods when Canadians wouldn’t have come out ahead with a variable rate are clustered around the late 1980s and early 1990s, when the prime rate spiked to 22.75 per cent and 14.75 per cent, respectively.
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There’s still a place for variable rates
Because variable rates have been the better deal historically, “I would say go with a floating rate, unless you would be disproportionately affected in a recession,” Milevsky told Global News.
However, if you think you might lose your job in an economic downturn or are financially stretched, you should go for the security fixed rate, he added.
Variable mortgage rates move up and down with the central bank’s trend-setting rate, meaning that the interest you pay on your loan may vary.
Often, your lender will keep your monthly payments steady during your mortgage term and adjust your mortgage bill at renewal. With so-called adjustable-rate mortgages, though, your monthly payments go up or down when rates move.
By contrast, a fixed-rate mortgage guarantees a set mortgage rate for the duration of the mortgage term. This means you don’t have to worry about the central bank hiking interest rates, but you also don’t reap any savings if rates do go down.
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Variable-rate mortgages
Things have changed
When Milevsky ran the numbers again in 2008, he found a similar outcome. Between 1950 and 2008, the probability of being better off with a variable rate was now just over 90 per cent, although the average savings had dropped slightly to $20,630.
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Still, many things have changed in the past 10 years, he told Global News in a telephone interview.
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That’s because Canadians used to have little or no bargaining power when it came to getting a fixed rate in the past. Banks would advertise their rate – something known as “posted rate” – and you could take it or leave it.
Nowadays, though, financial institutions are regularly offering fixed rates that represent a heavy discount on their posted rate.
“The numbers that are posted are almost meaningless,” Milevsky said.
The trend was already afoot in 2001, as he noted in his report.
“The long-term mortgage rates posted by banks and other financial institutions are almost always negotiable. In some cases, you might end up paying 1 per cent (100 basis points) lower than the advertised number. This is a recent trend in mortgage financing, which casts some doubts on the relevance of documented mortgage rates during the last 5-10 years,” he wrote.
In particular, the savings from picking a variable vs. a fixed rate “might not be as high (nor as volatile) as they were in the past,” he noted.
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On the other hand, the recent mortgage stress test rolled out by the federal government means that some Canadians will have less bargaining power vis-à-vis their lender when renewing their mortgage, Milevsky told Global News.
That’s because the stress test doesn’t apply to borrowers who renew their mortgage with their existing financial institution. This means that Canadians who wouldn’t pass the stress test will be forced to stay with their lender instead of shopping around for a better rate.
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Two other things that have changed are real estate prices, especially in Vancouver and Toronto, and Canadians’ level of indebtedness.
If you have, say, a 5 per cent down payment and are borrowing to cover 95 per cent of the value of your house, a variable rate mortgage is “not the right strategy,” Milevsky said.
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Never try to predict interest rates
Whatever you do, Milevsky said, never base your decision of whether to go fixed or variable on where you think interest rates are headed.
“You’re not a bond trader,” he said. And, in any case, economists and financial analysts often get it wrong, too.
In fact, even central banks “don’t really know what’s going to happen.”
For example, the Bank of Canada started raising rates in 2007, but then had to stop and reverse course as the global financial crisis took hold.
Similarly, some economists were predicting climbing rates in 2014. In fact, the opposite happened in 2015, when the central bank cut rates twice to stimulate the economy and help counteract the impact of low oil prices in Alberta.
Back then, “you would have been better off with variable,” said David Larock, a Toronto-based independent mortgage broker.
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Larock ran three scenarios for a hypothetical buyer who took out a $300,000, 25-year mortgage in the fall of 2014. Back then, interest rates stood at 1 per cent and subsequently dropped to 0.5 per cent by July 2015.
Since then, they’ve climbed back to 1.25 per cent. Larock compared a 5-year fixed rate of 2.84 per cent to a five-year variable rate of 2.3 per cent.
In the first scenario, interest rates rise to 1.5 per cent on Aug. 1 of 2018 and climb three times – on Jan. 1, April 1 and July 1 – up to 2.25 per cent in 2019. The floating rate borrower would face a highest monthly payment of $1,506 during the course of the term, compared to an initial payment of $1,314 and $1,395 for the fixed rate. But she or he would also pay over $8,000 less in interest.
In Larock’s second scenario, interest rates rise twice in 2018 – in August and October – and twice in 2019 – in January and April – prior to the borrower’s renewal in October. The results are very similar, with a maximum monthly payment of $1,506, although slightly lower savings of around $7,700 in interest.
In the third scenario, rates climb twice in 2018 and three times in 2019, in January, March and July. This time, the floating-rate borrower faces a highest monthly payment of $1,546, but still manages to pay $7,500 less in interest.
Milevsky advises borrowers to approach the fixed vs. variable question as a financial planning issue. If you pick variable, you should be ready for rate hikes and be OK with that.
“It’s a tough decision and it’s not going to get easier — but it’s about financial planning, not your research about interest rates.”