Choose A Fixed Or Variable Rate Mortgage?
Choose A Fixed Or Variable Rate Mortgage?
What a boring question! But hear me out. The answer can make a big difference to your financial position and life situation if you are a mortgage-having, home-owning sort of person.
Variable-rate mortgages and fixed-rate mortgages look, more or less, the same on the surface. You will make mortgage payments every month, or another time period that you choose. You probably do not spend much ruminating over your mortgage contract (At least, I hope not!). It is not hard to forget which type of mortgage you have.
The great thing about fixed-rate mortgages is that you always know what your interest rate and your payment will be for the term of the mortgage. As you pay down your mortgage, a portion of your payment goes toward the principal (the amount that you borrowed) and the rest goes to the interest paid to your financial institution for the privilege of using their money to purchase a property.
Many mortgage experts think that variable-rate mortgages are even more wonderful because financial institutions often offer them at lower interest rates than fixed-rate mortgages. Like a fixed-rate mortgage, a portion of your payment goes toward the principal and the rest to the interest you are paying to the financial institution. Since the interest rate changes with the variable-rate mortgage, the proportions of your payment that goes to the principal and interest changes. If rates fall, a larger proportion goes to principal. If rates rise, then a larger proportion of your payment goes to interest.
To complicate matters a little, a ‘closed’ variable-rate mortgage has payments that usually stay the same through the term of the mortgage so long as the interest rate portion does not exceed the entire payment amount. If interest rates soar, you will need to increase your payment amount or make extra payments. An ‘open’ variable-rate mortgage has payments that increase or decrease with prevailing interest rates.
First-time home buyers and their financial advisors typically love the stability of a fixed rate when just entering the mortgage space. You know what your payment and interest rate will be for the term of the mortgage. If you are a person who enjoys stability and predictability, a fixed-rate mortgage may be the best option for you. You might pay a little more, but you will sleep better at night.
The difference between fixed-rate mortgages and variable-rate mortgages is another reason to be sure you are not comparing apples to oranges when you are mortgage shopping. Fixed-rate mortgages often have higher rates than variable-rate mortgages.
One of the things that we are seeing much of in this uncertain climate are clients who need to break their mortgage terms for financial reasons or simply to move to the lower interest rates that are available.
The penalties that financial institutions charge for this are typically much higher on fixed-rate mortgages than making changes to variable-rate mortgages.
If you are considering converting your fixed-mortgage to a variable-rate mortgage, it is important to consider these potential penalties. Talk to your mortgage broker first. If you are currently up for renewal, you should have no issues with switching your mortgage, but it is always important to check your contract before making any changes that could “break” the mortgage. Penalties are determined differently depending on your current rate and term and the lender.
If the recent economic instability has you worried, and you want to change your variable-rate mortgage to a fixed one, the penalty will likely be equal to three months worth of interest payments. For those of you who are looking to take advantage of the decrease in interest rates, and want to switch your fixed-rate mortgage to a variable-rate one, you will likely be looking at an Interest Differential Penalty. Depending on your mortgage amount, this may be a small price or a very large price to pay to achieve a lower interest rate and reduce your payments. I can do the calculations for you.
Regardless of whether you are leaning towards fixed or variable, or want to change your mortgage, it is always a good idea to review your mortgage contract and finances with your mortgage broker before making any changes. I would be more than happy to discuss your current financial situation and review all the options with you to ensure you are making the best choice for your future.
Jay Brennan
DLC Estate Mortgages Lic #11363
416.795.1079