The Toronto
Thursday, April 28, 2011
Variable-rate mortgages can save a lot
Long-term savings entice, but consider your risk-tolerance
Leanna Mamatis and her husband Rick knew exactly what they were after when they sold their home in North York and bought a new one in Markham
They wanted more space, but not too much, and a swimming pool in the back yard.
Mamatis also knew what she was looking for on the mortgage. Even though interest rates are poised to increase, the couple decided to go with a variable-rate mortgage for a three-year term.
"It's lower than the fixed rate," Mamatis said. "I'm not a financial expert, but it seems to me that interest rates are not going to go up too fast too soon. I just wanted to make the payments as minimal as possible in terms of the interest."
With other pressing expenses, such as tuition and fees and lessons in music, karate, hockey and baseball for their four teenagers, making extra mortgage payments is not a priority right now, Mamatis added. "But if we can put a chunk of money down on the principal, then we will."
Research shows that homeowners who take a variable-rate mortgage can save much more over the life of a mortgage than those who stick with a fixed rate.
But even those experts caution that variable mortgages, which go up and down with the prime rate, aren't necessarily right for everyone. What looks best on paper may not be what fits your life.
If you opt for a fixed rate, you know that your payments will not change over the mortgage term. You'll pay a higher interest rate in exchange for that peace of mind.
A quick glance at RateSupermarket.ca shows the great divide between fixed and variable.
For a $200,000 mortgage at a five-year fixed rate of 5.69 per cent, you'll have a monthly payment of $1,243. Over the 25-year life of the mortgage, you'll pay a total of $372,898, of which $172,898 is interest.
On a variable rate of 2.85 per cent, your payments on a similar mortgage are just $931 per month. You'll pay total interest of $79,350 over the life of the mortgage.
Of course, that assumes your variable rate stays the same, and that's an assumption you just can't make.
That's why homebuyers must give a lot of thought to their tolerance of risk and the state of their personal finances when they decide on a rate and a term. Ask yourself: if you choose a variable rate and rates go up, will you be able to afford the higher monthly payments?
In 2001, Moshe Milevsky, a finance professor at York University
An update in 2008 also came down on the side of variable rates.
"That study has to be taken with caution. It is a probability argument," Milevsky said.
"It's a lot like buying stocks and bonds. While overwhelming research shows that stocks outperform bonds most of the time, there will be prolonged periods of time when bonds do better.
"That's why we always tell people with investments, if you can't take the chance of losing money and you don't have the risk appetite, don't put all your money in stocks."
The Bank of Canada, which kept interest rates at historic low levels to support the economy through the recession, is expected to begin raising rates later this year.
Mortgage broker Jeff Mayer of Mortgage Intelligence has clients with variable mortgages asking if they should lock in before rates rise.
"I tell them you have to look at the trends and the past history. The rates will go up in time, but the Bank of Canada
The difference between a variable and fixed rate right now is one percentage point or, in some cases, even more.
Broker Paula Roberts urges clients to think about the term of the mortgage.
"Most people automatically go to the five-year term. Sometimes they don't even realize they have other options," said Roberts, a broker with Mortgage Intelligence.
"People need to think about their plans for the next three to five years. If you know you're going to be moving or having kids, you can take a shorter term. If you want the certainty of the fixed rate, you can choose a longer one."
She also suggests that borrowers with a variable rate set their monthly payments at a higher amount, closer to the fixed rate. The excess will go directly to the mortgage principal and if your rates go up and you lock in, there won't be any payment shock.
"Start with your own financial goals and work backwards from there," said Colette Delaney, senior vice-president at CIBC Mortgages, Lending and Insurance.
"Interest rates can change, but so can things in your life, particularly for younger people. You may be changing jobs and moving away or starting a family in the next couple of years," Delaney said.
For instance, you probably have other financial goals, such as saving for retirement or your children's education.
"Just because you take out a mortgage doesn't mean you forget about all your other goals or saving a little bit each month. If rates move up, are you still going to be able to put money away in that RESP or take a holiday?
"It's not just about looking at the interest rates today and choosing the lowest one; it's about looking at the years to come and having a mortgage that will allow you to adapt."
