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Are variable rate mortgages still a good idea?

My phone has been absolutely blowing off the hook since all of the mortgage rate hikes that have been taking place from the bank of Canada since about the spring of 2022. People are concerned because the rates have gotten so high, especially for those that went into a variable rate mortgage during the time when mortgage rates were so low they don't know what to do. There's phone calls flying around from the banks all over the place trying to encourage people to lock in. And today's post is not so much of whether it's a good idea to do that right now or not, but more so to make sure that you absolutely understand what you are betting against when you decide to take a fixed rate mortgage over a variable rate mortgage. If you are someone who's in this position that maybe has a variable rate mortgage and are thinking of locking in, this is definitely the post for you.

Or if you're somebody looking at buying a home and you're trying to figure out what is best for you, you definitely want to read this. You ready to get into it? Let's do it. What's good everybody? It's Darin Germyn from the Germyn Group, where we know you've only got one chance to either buy or sell your next home.So we're here to help you get it right.

This post today is all about the difference between getting a fixed rate mortgage versus a variable rate mortgage. And if you are leaning towards the security and the assurance of what comes along with having a fixed rate mortgage, you want to really consider the two bets that you're making when you decide to go that route.

As I just mentioned, many people decide that a fixed rate mortgage is best for them. And the reasons for that are fairly simple. A fixed rate mortgage offers consistency in the payment, there's really no surprises, and it also offers some security against rising interest rates. This all certainly is true, and we're going to get into the first bet that you make when you decide to take a variable rate mortgage. And that bet is you are banking on the interest rates, or rather the interest payments over the life of your loan exceeding that of which you could have had if you got a fixed rate mortgage.

This means that you are convinced a variable rate mortgage ultimately is going to get more expensive in the long run than the fixed rate product that you might have access to right now. Let's do a little bit of an example, let's say there is a fixed rate product at 5% and you can also get a variable rate mortgage for the same term of approximately five years for 1% less at 4%. Now, in most cases, and historically the bank of Canada, whenever they've decided to raise interest rates, they usually do so by about a quarter point each time. And this is for many reasons, but mainly to not shock the economy with monstrous rate hikes. So since we have this 1% spread between the fixed rate and the variable rate, the first bet is that really you're thinking that the interest rates are going to increase by a quarter point at least four times, thus matching what the fixed rate available is right now.

Or better said, that's four increases over the life of your mortgage. So in this example, the variable rate now matches the fixed rate that you could have got. So while this may not feel that great, you've got to remember that over the time that it took for the variable to now match the fixed rate, you've saved some money over the course of that time. Just because the rate is now equal to what the fixed rate was previously, that doesn't mean it's bad. That just means it's equivalent.

And again, you've saved money all over this time. So you really haven't lost anything other than maybe the security that it may not go higher. However, let's use the example that the rate continues to move and let's say it went from 4% to 5% and let's say it goes even a percent higher, getting increased maybe up to four more times, up to a rate of now 6%, a full 1% higher than where the fixed rate was at the time that you got your mortgage. You need to remember there was a period where you were actually saving money with the variable rate over the fixed rate. And now with this fictitious example, you are now starting to give some of those savings back because the rate is now exceeding the fixed rate that was available at the time.

So the question is how long does that need to continue until you actually start losing money? So by choosing a fixed rate mortgage over a variable rate mortgage, you're really making a bet that you're going to give back all of the savings that you've acquired over the term of your loan. Definitely something to think about because you have to question how many times in history has that actually happened? The extra seasoning that I want to put onto this is really that a mortgage is typically a 5-year term for most people. So the rate may go above where the fixed rate was.

But will it actually stay there or will it return to levels that were below where the fixed rate was initially? Hard to say, but you need to take that all into the account when you are making this first bet so that leads us to bet number two. And bet number two is that you are not an average person. And if you're like most people, you probably are an average person. What I mean by that is the house always wins, like they say in Las Vegas, and in this example, the banks know that there is a six out of ten chance that you will not see your mortgage through to the full contract term.

The banks don't necessarily tell you this and they want you to break your mortgage because it really pays off in this case for them. So the big five banks and also many credit unions, what they do is they charge their mortgage penalty to be canceled and they use something called an interest rate differential. This is a mortgage penalty that is traditionally about four and a half percent of the loan amount that you've borrowed. This can amount to thousands and thousands of dollars in penalties if like six out of ten Canadians, you do not see your mortgage to the end of your five year term. Now, you may also think, well, hey, I'm not average.

I'm like the four out of ten Canadians who won't break their mortgage. And that very well may be true. But the important thing to remember is that life changes and life can change very, very quickly. You could have family changes like having children. You could have financial changes like a job promotion or a job loss.

There could be health challenges that maybe prevent you from working. There could be changes in your relationship and your family dynamics. Five years is a really long time to think about where you might be and what your life might look like, especially if you're reading this post and you are a younger person who is maybe just starting their career or starting to date and court other people or anything like that. It's a long time and you need to be very careful about committing to something for five years when you might not know what the future necessarily looks like. So we know that the interest rate differential is tied to a fixed rate mortgage.

This is where variable mortgages start to become a lot more attractive variable mortgages and the penalty attached to them are calculated with a three month interest penalty, which is typically significantly less than what you would pay when you do a fixed term loan. In fact, a fixed term loan penalty versus a variable rate mortgage penalty is typically nine times the amount of what it would be if you had chosen a variable. So these are the two bets that you are really taking on when you decide to get a fixed rate mortgage and you've got to really account for. Is this the best decision for the next five years for you? There are many great studies on this, but one in particular that will be linked below this post where you can see that historically variable rate mortgages have significantly outperformed fixed rate mortgages for years and years and years.

So what happens if we find ourselves in an environment where rates are going up at a pace or speed that is a little unprecedented or it's just generally getting more expensive to have a mortgage? Well, you just need to remember that this isn't forever. A mortgage term is a long time and likely five years. So when you get your mortgage and the rates maybe go up, just remember that they can also go down just as easily as they did go up. You're going to want to make sure to ask whatever lender you choose to work with how the penalty on your mortgage is calculated.

Should you need to cancel your mortgage because you want to sell your home or have to sell your home in the future before your term is up, don't just focus on the rate, because this could save you thousands and thousands of dollars and help you be more financially successful in the end. So that's it everybody. I want to thank you for reading. I hope this makes sense. Please leave some comments below and let me know what you think of this content and if you have any questions about the differences between fixed and variable rate mortgages while you're scrolling around down there as well.

You'll also find a link to my calendar where you can book a time to speak directly with me if you have any questions about buying or selling a home in the Surrey, BC and surrounding areas. Guys. I'm Darin Germyn with the Germyn group. You've only got one chance to either buy or sell your next home. We're here to help you get it right.

Talk to you in the next post,

Cheers

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Darin Germyn PREC* & Adam Howsam
Macdonald Realty LTD
homes@germyn.ca | 604-542-2444 | germyn.ca
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