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  • Fixed vs. Variable Rate Mortgages: Which one is better?

    Author: Randy Johnson Date: September 1, 2015

    Fixed vs. Variable Rate Mortgages: Which one is better ? As of October 2013

    Over the years borrower’s who have chosen a Variable Rate Mortgage VRM have often come out ahead. Lower interest rates, lower payments and considerable savings have typically resulted. In the past I saved one client almost $81,000 on their $500K+ mortgage. It’s unlikely we’ll see those savings for some time, but it shows one how important this decision can be.

    Currently 5 year bond yields have seen a net increase by about ¾% over the past several months. These bond yields directly affect 5 year interest rates on mortgages. The gap between a 3 year VRM and Fixed Rates have increased to a point where one should closely examine a VRM as a mortgage option.

    The Conclusions:

    If we compare a current $400,000, 5 year fixed rate to a 3 year VRM, one would save over $13,000 by choosing a VRM. A similar comparison to a 3 year fixed rate, one would save over $9,000.

    If we compare a 5 and 3 year fixed rate to a VRM where prime increased by ¼% every 6 months, the savings would be $9,126, and $4,411. The ending prime would be 4.0%

    If Prime increased to 5.0% over the 3 years, we would have a ‘break-even’ situation. Prime would be at 5.0% and the fixed rate would be a minimal $265 better.

    If you feel Prime will increase beyond 5.0% in 3 years, a fixed rate would be best. Otherwise a VRM may be the best choice. Your VRM monthly payments will not skyrocket, and will still result in lower payments if Prime reached 5.0%.

    In the event we see prime increasing dramatically, you should be aware that almost all lenders will allow you to lock into a fixed rate at no cost or penalty. There is a ‘safety net’.

    The Data:

    Mortgage Type & Size Interest Rate Monthly Payments Total Payments Ending Principal Balance Amortization
    Savings
    5 Year Fixed Rate
    $400,000
    3.69% $2,037 $73,346 $368,971 25 Years  
    3 Year Fixed Rate
    $400,000
    3.29% $1,953 $70,308 $367,375 25 Years  
    3 Year Variable Rate
    $400,000
    Prime = 3.0%
    2.5% Prime – 0.5% $1,792 $64,507 $364,051 25 Years A VRM saves $13,760
    over a 5 Year Fixed 

    A VRM saves $,9,126
    over a 3 Year Fixed
    3 Year Variable Rate
    $400,000
    Ending Prime = 4.0%
    2.5% for the 1st year, then increases ¼% every 6 months $1,861 Ending Payment $65,285 $367,988 25 Years A VRM increasing by ¼% semi-annually after Year 1 saves $9,045 over a 5 Year Fixed

    A VRM increasing by ¼% semi-annually after Year 1 saves $4,411 over a 3 Year Fixed
    3 Year Variable Rate
    $400,000
    Ending Prime = 5.0%
    2.5% for the 1st year, then increases by ½% every 6 months
    $2,068
    Ending
    Payment
    $68,349 $359,599 25 Years This is essentially a ‘break-even’ situation.  The fixed is marginally $265 better.

     

    We would always want to track the economic outlook when following prime and bond yields. While no one has a crystal ball, it can be useful to see where we are headed. Prime has currently remained at 3.0% for just over 3 years. Most economists suggest we may not see it change for about another year. Hence I prepared a "Sensitivity Analysis” of the Fixed vs. VRM waiting about a year before an increase. Additionally we know that these analyses can change weekly or monthly. One must keep them up-to-date. I would be happy to review your situation at any time, on a case by case basis.

    Historical Facts

    In 2001 a Finance Professor at York University, Moshe Milevsky did a study of Fixed vs. VRM mortgages using "basic financial and statistical concepts”. In reviewing data from 1950 to 2000 he concluded one was better off in a Variable Rate Mortgage VRM 88.6% of the time. "The good really appears to outweigh the bad in this equation”. This favourable pattern increased to 90.1% by 2008.

    Historically, choosing a VRM is the better option 9 out of 10 times.

    "In updating the data to 2008, we confirmed that savings accrue to homeowners who eschew the temptation to forecast interest rates and are willing to accept risk and finance a mortgage with a float-or a variable-rate mortgage.”

    "Practically speaking, we interpret the updated data as further evidence mortgage financing continues to be a risk-and-reward decision that must be integrated within the client’s personal balance sheet and risk management strategy.”

    Please stay tuned for more comparative advice. It really works!



    Mortgages Financing Fixed Rate Variable Rate

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Author : Randy Johnson
I have enjoyed over 30 years as a Professional Accountant, a Commercial Real Estate Lender and an expert Residential & Commercial Mortgage Broker. I’ve taught First Time Buyers courses with the Vancouver and New West School Boards. My goal is to provide my clients and students with the best possible mortgage advice. One of the most valuable methods is to provide a detailed analysis of various mortgage options that clients have available. Without it, one can only give ‘shoot-from-the-hip’ type of ‘opinions’. These may not be good for clients. We often see this type is incorrect and can result in questionable, if not terrible choices.