Thursday, October 28, 2021 02:19

Fixed Rate Vs. Variable Rate

Fixed or Variable?

You could poll 50 economists, mortgage brokers and other financial experts and they all might have a different answer to the question of whether to chose a fixed or variable rate for your mortgage. Mortgage rate are constantly in flux and whether or not a fixed or variable rate will create the most savings is dependent on a number of factors.

In Canada approximately 66% of mortgage holders have fixed rate mortgages as opposed to 29% who have variable or adjustable rate mortgages.

Perhaps most telling is that fixed rate mortgages are more common with younger people while those choosing variable rate mortgages tend to be older. In the First Time Homebuyer demographic fixed rates constitute 69% of mortgages.

The Variables of Variable’s

Variable or adjustable rate mortgages are interest rates set with a differential to the Prime Rate. Typically this will be Prime Rate Less a certain percentage. For example If Prime Rate is 3.00% and you are offered a discount of 0.60% to Prime then your interest rate will be 2.40%.

This differential of 0.60% will always remain but it is variable or adjustable because Prime Rate itself fluctuates.

Prime Rate is largely based on economic factors within the country and around the world.  Depending on the state of employment, inflation, manufacturing the Bank of Canada will review its Overnight rate.  The Bank of Canada meets 8 times per year to review their overnight lending rate which is directly tied to mortgage lenders Prime Rate. Typically Lenders will change their Prime rate almost immediately after a change to the Bank of Canada changing their Benchmark Rate.

How Fixed Rates are Fixed.

Fixed rates are also predominately driven by economic factors. However unlike variable rates, fixed rates are correlated to changes in the bond market.

When investors are nervous about the economy and financial markets they will pull money out of the markets and put it in the security of government bonds. As a result this drives the yields of these bonds lower.  Usually as the bond yield increases or decreases so does most lenders fixed rates.

Therefore when the economy or financial markets are suffering you will tend to see lower fixed interest rates as bond yields are lower. When the economy is robust yields increase and interest rates increase in turn.

It is important to note that when bond yields increase lenders are more reactionary to increase their rates as opposed to when bond yields decrease. A decrease in bond yields may see no savings passed on in a reduction of interest rates however you are sure to see an increase in rates when bond yields increase.

So since both fixed rates and variable rates are based on similar economic factors we can assume that their ups and downs will imitate each other. The following graph shows a comparison between Prime Rate and Posted Mortgage rates from1980 to the present.

What Rate is best for your situation?

As the graph displays fixed rate and variable rate are often very close. That is why its difficult to say which is better.

Whether you choose a fixed or variable rate will depend on current conditions and your risk tolerance.  If you are a first time home buyer who wants to know what his payment will be every month and not worry about your payment increasing, then fixed is probably the way to go.

If you want to pay your mortgage off as fast as possible and can accept that your rate may increase at any time then maybe a variable rate is worth considering.

Both fixed and variable rates have their own advantages and disadvantages.  If you have more questions about rates contact our team to determine what will make the most sense for you.