Fixed Rate or Variable Rate Mortgage – Which is Best?

Ok I’m angry. I read an article today from the Vancouver sun that angered me greatly as it fails to take into account the complexities of the “variable versus fixed” debate that nearly every client goes through during the mortgage approval process.

The article was in the Vancouver Sun, and was written by Garry Marr “Family Man” on November 22nd, 2008 and went as follows:

———— Begin Article ————

When it comes to ranking some of my biggest financial blunders, getting a fixed-rate mortgage when I purchased my first home is right near the top.

“Don’t lock in, mate, it never makes sense,” I remember a senior columnist at the Financial Post telling me about 11 years ago when my wife and I decided, pre-kids, to lock into a bigger commitment than our marriage.

The gap at the time between a fixed-rate mortgage with a five year term and a variable-rate mortgage tied to prime was so scant it hardly seemed worth the risk.

But even a difference of 50 to 75 basis points – there are 100 basis points in 1% – turned into a few thousand bucks lost over the five-year term.

By the time we moved up to a bigger and better house, I didn’t need much convincing to go with a variable rate product.

Of course, it has saved us money.

The question is: does it still make sense to go with a variable rate based on market conditions that have changed dramatically in the last eight weeks?

By way of background, in early October, banks were offering variable rate products for about 60 points below prime.

A few months before that, it was almost 90 basis points below prime.

But then the credit crisis hit and variable-rate products switched overnight to 100 basis points above prime.

They have stayed there ever since, leading some of us to question whether they still makes sense.

Gary Siegle, Calgary regional manager with InvisInc, a mortgage consultant firm, says while deals are not as good as they were in September, there is no question a variable rate mortgage will save you money.

This week, the lowest rate you could get on a five-year fixed-term mortgage was about 5.5%, Mr. Siegle says. “Plus, what do the economists say will happen to rates? They say they’ll go down.”

There is one other factor added to the mix. The Bank of Canada’s rate, usually tied to prime, went down last month, and some of the major banks refused to go along with the cut because it would have cost them too much money.

“Will banks change their rates when the Bank of Canada reduces its rate? It’s a good question.

But the last time they resisted, it didn’t last long before whatever influence the Government of Canada had was wielded and they all followed suit,” Mr. Siegle says.

The problem for banks are all the customers with existing mortgages negotiated at 60 to 90 basis points below prime.

Every rate cut costs the banks money. They are actually losing money on those customers now.

And, according to Mr. Siegle, that is one reason that if you have a variable-rate at a rate below prime, you would have to be “very worried” or “very conservative” to want to lock in that rate.

You would be converting a mortgage as low as 3.1% to one at about 5.5%

“Those people are sitting pretty,” Mr. Siegle says.

Don’t feel too sorry for the banks. They had been pushing variable rates up until the credit crisis hit.

The Canadian Association of Accredited Mortgage Professionals said this week that about 40% of home loans negotiated in the past year were variable-rate products tied to prime.

“We don’t know what the impact of getting rid of the discount will be,” says Jim Murphy, chief executive of CAAMP.

Don Lawby, chief executive of Century 21, says even with variable-rate products now 100 points above prime, the issue has not changed.

“It comes down to what you can afford and what is your comfort level,” Mr. Lawby says. “For many consumers, they feel comfortable locking in for five years.”

Ultimately, a fixed-rate product is still like an insurance policy.

Yes, it will make some people more comfortable. I don’t know about you, but I don’t feel all that comfortable paying more interest.

———— End Article ————

This article had several points that upset me and have left me feeling like I should respond. Unfortunately, the Financial Post likely won’t indulge me as much as I’d like them to in terms of space, so I have to respond here to my readership.

The first point that I’d like to discuss is the idea that there is, potentially, a 50 to 75 basis point difference between fixed and variable rates. The article seems to suppose that a variable rate mortgage will be lower than a fixed rate mortgage. Traditionally, that has been true, but anyone seriously acquainted with bank rates across the country will know that you can actually get a fixed-rate mortgage BELOW a variable rate mortgage.

I am able to get 4.90% on a 5 year, fixed, locked-in term and only 5.00% on a variable rate mortgage tied to prime (prime is currently prime and the rate is set at prime + 1%).

So, currently, you can SAVE money with a fixed rate mortgage. Now, this IS an unusual situation, but these are unusual financial times, and conventional ideas don’t hold up when the fundamentals in the market have changed.

The next issue I have is that the author, and even the consultant at Invis they spoke to, said that “…there is no question that a variable-rate mortgage will save you money.” I cannot abide by this statement, when I can CURRENTLY save you money by taking a variable rate mortgage, and should prime rate NOT fall at the banks, then you are exposing yourself to the risk of rising payments and interest AND taking a higher rate. I hardly think this is a good idea.

The banks do not have to follow the Bank of Canada when the Bank of Canada lowers it’s lending rate. We already saw evidence of this the last time the Bank of Canada lowered rates. It took several lenders several days to lower their prime rate, and there was no influence by the Bank of Canada exerted to make them lower their prime rate. The fact they lowered prime was solely a function of them doing what all companies do: reduce their margins to gain market share. The truth is, that when prime rate was 4.5% and mortgage rates were prime + 1% the banks WERE making money. When the Bank of Canada announced a reduction in its key lending rate, the banks were hesitant to reduce their profits by lowering their prime rate. Several banks and mortgage lenders took many days to reduce their prime rate. The charge was led by TD and Scotiabank who dropped their prime rate on the same day. Initially it was only by a fraction of the overall change, but by the end of the week they had lowered it the same amount with the Bank of Canada. Again, there is no law or any way the Bank of Canada can influence ALL the banks and lenders. They simply don’t have the leverage or “teeth” to do so.

Let’s not forget that the prime rate is currently 4% which is getting pretty damned close to 0%. Do you honestly think there is that much room left for prime rate to go down? Seriously? Do you think prime rate is going to get to levels at 0% or something and that lenders will continue to lend? Would you??? There is a limit to how much rates can fall, but there is a HUGE amount of room upwards.

The closing sentence made me actually laugh out loud in this case. The idea that the author isn’t comfortable with paying more interest is laughable when I am actually advertising fixed rates BELOW the variable rates he is advocating.

A lot of bankers, mortgage brokers, and media, have been singing the praises of variable rate mortgages, and when the conditions have been right, so have I. When we were getting 90 to 100 basis points below prime rate, it made good financial sense: prime rate was higher (with more downward potential) and fixed rates were substantially higher (sometimes up to 1.5% higher). However, that time has changed.

The one person I agreed with in the article was the chief executive of CAAMP – the governing association for mortgage brokers. The key to the question really is what you can afford and what you are comfortable with. Comfort was overlooked in this article as though only blundering fools would take a fixed-rate mortgage and fixed payment.

There four types of people that buy in the market, in my experience:

1. Those that buy far below their means, safely, and have relatively stable income
2. Those that buy the maximum they can afford, and have relatively stable income
3. Those that buy far below their means, safely, and have variable income (commissions or bonuses)
4. Those that buy the maximum they can afford, and have variable income (commissions or bonuses)

For self employed people, or people whose income varies dramatically, does it really make sense to take the risk of a variable interest rate (and therefore a variable payment) when their income isn’t a sure thing? Having variable income AND a variable payment is a recipe for budgetary problems. If there was a substantial savings available (now or in the future) by taking a variable rate mortgage, then perhaps it is worth consideration.

When fixed rates are at (or below!!!) variable rates, with not a lot of downward potential, fixed rates provide customers savings AND comfort. This isn’t all that common, but right NOW is the time to have this discussion with an Accredited Mortgage Professional, and not a member of the mass media.

Please, post your comments on this. I argue with mortgage brokers and bankers about this damned near every day, and most of them stand by the dogma that “variable is best,” without having any economic facts or education to back up their opinions. They are just doing what the rest of the herd is doing, and this is NOT the time to run with the herd.

~ by merc359 on November 23, 2008.