First mortgage: Fixed or variable?

Question

I am a first time home buyer and need a mortgage. The house I’m going to buy will cost about $400,000 and I am putting 10% down. My bank has offered me a 3.09% fixed rate, if I lock in for 5 years. This sounds pretty good, but I’m wondering if I should go with a fixed rate or a variable rate. Any advice?

Answer

New Brunswick Sturgeon or Blue Arctic Char? For a fish lover these are both great options. When it comes to choosing between a variable rate or fixed both are great options too. That’s because interest rates are so insanely low these days. But I think what tips the balance in favour of a fixed rate these days is that the price you pay for certainty is incredible low.

Even just a few years ago the variable rate mortgage was the better option for those people who were willing to take a risk on interest rates. Moshe Milevsky, a professor at York University, published a study that outlined “detailed evidence that Canadian consumers are better off, on average, financing a mortgage with a short-term (variable) interest rate, compared to a long-term fixed rate.” Milevsky’s fundamental conclusions remain relevant, but at this particular point in history, fixed rate mortgages have become way more competitive.

That being said, there are three factors to think through as you look at the variable versus fixed question for yourself: Goals, math and emotions.

Outline your goals before choosing a mortgage

Before you decide whether to go variable or fixed, outline your goals, says Joe Jacobs, a mortgage broker at Mortgage Connection Inc. For example, “If you are looking to pay down your mortgage debt as fast as possible, you will likely want a different product than if you want to maximize cash flow.”

Variable versus fixed is only one of the things you’ll need to decide. It is also really important to consider other mortgage options you might not know about such as lump sum and flexible payments. You can talk through your goals with the mortgage specialist at your bank, or find a mortgage broker to help you assess the options at a number of different lenders.

Run the numbers on different scenarios

Ask your mortgage specialist or broker to run the numbers on different scenarios. If interest rates rise by 1% in the next 5 years, how much more you will pay in interest, versus if rates stay put. How does the math change if rates go up by 2%? And how much will your monthly payment change in each of these scenarios.

You should know that many lenders will let you “fix” your payment even if you have a variable rate mortgage. What this means is that as rates rise you’ll simply pay more towards interest than and less towards the principle. This is a way to have certainty with your monthly payment, but without paying the higher rate to go fixed.

Know yourself and how you feel

The third factor is your emotions. Mortgage broker Joe Jacobs provides this litmus test on whether to choose variable or fixed:  “If you are driving in to work and you hear that the Bank of Canada is raising rates, will this cause you to panic, pull over and call me? If so, you should go fixed. Variable clients need to be okay with fluctuation.”

Signing up for your first mortgage is a big deal. Ask questions to ensure that you get the best product for your circumstances, and when it comes up for renewal in five years ask these questions all over again. Don’t fall into the trap of renewing without thinking because you may miss out on getting the best deal available.

About Bruce Sellery

Bruce Sellery is the CEO of Credit Canada, the country’s longest-standing non-profit credit counselling agency. He is a former MoneySense columnist.