It’s an interesting time for mortgages where the spread between variable and fixed rate mortgages are relatively small. Right now, variable mortgage rates are in the prime + 0.8% range (3.3%) and the best 5 year fixed rate mortgage is approximately 3.95%.

With the **speculation of increasing inflation**, it would perhaps make the most sense to go fixed for new home buyers. But what about those with existing variable rate mortgages? For example, I have a discounted prime – 0.85% (open) mortgage with about 2 years left on my term. At today’s historically low prime rate, I’m paying 1.65% interest on my mortgage, but where will prime be when it comes time to renew? I’m guessing that it will most likely higher.

Here’s what Ed Rempel (CFP and CMA) thinks:

We have been recommending variable mortgages (or 1-year fixed) since the mid-90s, and there have been only a few relatively short periods where the discounted variable rate was as high as 5%.

One study I saw from a mortgage broker showed that five 1-year mortgages would have been cheaper than one 5-year mortgage 100% of the time since 1950. Variable mortgages would also have almost always saved money.

Ed is simply re iterating the fact that historically, discounted variable rates have saved money over 5 year fixed *most* of the time. However, could the current situation be one of those unique times where a fixed rate mortgage would win over a discounted variable? At least for the short time frame that I’m looking at?

Sampson had some good advice for me on the **Canadian Money Forum**:

FT, you would have diversification of interest rate risk though, since you are also doing the SM – and you could obviously increase your HELOC amount if rates remain low. Not as good as your Prime-minus – but still below 4%.

It’s a good point that all of my debt is variable, and getting a portion of my debt as low rate fixed may be a wise move.

Even though I’m typically a big believer in discounted variable rates, here’s why I am leaning towards taking the fixed rate:

- Variable and fixed rates are near historic lows which leads me to believe that they will move up from here.
- My current mortgage is
*open*, thus no penalties to switch. - High inflation is potentially on the horizon, thus a higher prime rate. To put this in perspective, 6% prime is the historic norm.
- My mortgage is fairly small (~$75k) (interest diversification) and I plan to pay it off completely over the next 5 years.

The reasons why I’m hesitant to switch:

- My variable rate is currently much lower than the fixed rate offered (1.65% vs 3.95%). This equates to about a $100/month payment difference.
- Economy looks like it will stay depressed for 2009, which will most likely mean that prime rate will remain low in the short term.
- Really can’t predict where rates are going to be in 2 years. Discounted variable rates may be available again and inflation may not be as aggressive as predicted.
- If we were to get aggressive in our mortgage pay off, it may be possible to pay off our mortgage completely before the term is up.

So what do you think? Any of you with discounted variable mortgages looking at switching to fixed rate soon?

If you would like to read more articles like this, you can sign up for my*free*weekly money tips newsletter below (we will never spam you).

Rates have nowhere to go but up. I doubt they’ll skyrocket overnight, but I imagine once they go up even the slightest, they’ll go up every chance they get. I think I’d wait for them to go up once before I went fixed.

I wouldn’t do a 10 year fixed either … that’s just giving the bank money

That’s a tough call, if you think you can pay off even half the mortgage over the remainder of the term, then I wouldn’t switch. No matter what the rate is in 2 years, it won’t mean much in dollars on a mortgage that’s less than $40,000.

My choice was simpler, I just signed a 5yr fixed on a new house. Since the choices were within 1%, I consider it a premium paid to guarantee my rate for that time. If the prime rate goes up at least 1.5% in the next few years (quite likely) I’ll know I made the right choice.

It will get me through what we hope to be a couple maternity leaves for my wife and then hopefully 5 years from now I can go into a P-1% variable.

I agree with CF – in your case it won’t really matter which choice you make.

FT,

I’m in the same boat. My mortgage is up at the end of July and I’m stuck about what to do.

I’m leaning towards just doing variable and paying down what I can over the next few years. The savings there might out way any rate increases for the next year or two. So the decision is really a function of when are you paying off that debt. If it is sooner, go variable, if later go fixed.

My two cents,

Tim

After talking this over with my wife recently, we may go with aggressively paying off the mortgage before the term expires. Since we do have a significant (to us) amount of savings, we might just dump it all on the mortgage and go from there.

Thanks for the tips folks!

Do you think the bank would negotiate a fixed rate lower than 3.95% because you have such a good rate on your variable? Have you asked the bank to see what they would move to if you converted to fixed?

I have a variable at Prime -0.75% with 4 years left and am considering converting too.

One thing to keep in your calculations is the fact that you can afford for the rate to go higher in the future the longer you keep a lower rate up front and actually end up ahead. What I mean is your 1.65% on $70,000 makes a bigger difference in the principal you’re able to pay off in the first year, and the impact of a higher rate a year from now is less than locking in right away.

I haven’t had the chance to run a spreadsheet to calculate what the exact break even point was as you make your payments, but I’m generally in the same boat – staying variable (just renewed at 3.3%) and paying off the mortgage aggressively.

lock in when you see signs of rates going up, speculation is nothing more then speculation..when rates do start to go up they wont be going up in increments of 5%, so why worry?? at 1.65% you pretty much got a free loan, take advantage till the end.

Why not have your cake and eat it too?

Some banks will negotiate a mortgage, then let you pay an unlimited down payment against it. Thus you could have a mortgage with a max value of $75,000, but only a small amount owing against it. You could then easily & cheaply stretch it back to the full amount. It’s like having a fixed rate LOC. Friends did this with Scotiabank some years ago, so I don;t know if the option is still available.

DAvid

I have been thinking about this switch as well. I have a P-0.4% open. Rates on 5 yr fixed are as low as 3.55% today (check RFD for the daily updates). Some banks (CIBC) are offering cash back deals as well, such as 3.65+0.5% cash back.

We have a larger mortgage and will not be paying it down super aggressively, so it might make sense to lock the rate in soon. Since it’s an open rate, I might just get a broker to keep an ear out. It would have to be less than 3.5% before I’d consider it.

I agree that variable rates arent going to get much lower, maybe another quarter. I also think there’ll be almost half a year here where there won’t be significant increases. But there may be some significant increases in 2010-12 if we get inflation and hyperinflation with all this money being created.

Looking at the US 5- and 10-yr bonds, it seems they’re itching to break open. But a round of poor earnings could be put a quick stop to that.

Sounds like you’ve chosen an excellent option, as pointed out, you always have the option of borrowing more in the future if rates remain low.

On the other hand, maybe instead of paying it off aggressively now, invest the top-up amounts in some bonds (or bond funds paying out monthly) and if rates go up – put all that money towards your mortgage (since it’s open).

Hey Sampson,

I’m not sure I understand your rationale behind investing in bonds. Isn’t this a poor time to have money in bonds with inflation around the corner (except real return bonds)? If bond yields are to go up, that means that bond values will have to come down.

If you can accumulate savings/investments that are very conservative, but yielding better than 1.65%, grow that as your ‘mortgage pay down’ fund and liquidate it the day rates swing out of your favor and apply it to the mortgage.

I think you’ve got the opportunity to do this because your exceptionally low rate AND open mortgage AND low principle balance. In real $, I dunno if it’ll make a difference, but beating 1.65% return even in this market should be quite possible.

Hi FT,

I have the same question. As you mentioned, according to historical data, current mortgage rate is as low as it can go. I just bought the house and have about 300k mortgage and not much savings. I am inclined to change my current variable rate at 3% to 10 year fixed at 5.1% later this year because I am afraid that the inflation will be going through the roof after 5 years. Plus it is more of an insurance premium to pay that 2% for the next 2-3 years since I won’t be able to afford the house if the rate is going up to 10% in 7 years. The risk of not be able to afford the house probably outweigh the 2% premium I would be paying. What do you think of this strategy? Am I going to conservative? Thanks!

Think of it this way: how much lower can rates really go?

Do you think that over the next 5 years the interest rate will not rise above the current price of a 5-year fixed rate mortgage?

I think this is one of those periods where the historical trend of saving with a variable will be exempt. The logic is very clear to me and saving <1% in interest costs doesn’t outweigh the risk (IMO) that you are exposed to trying to time the lowest fixed rate you can get.

@Nurseb911

“Do you think that over the next 5 years the interest rate will not rise above the current price of a 5-year fixed rate mortgage?”

It’s not that simple. If the rate stays below for the first four years and only goes over in the last year it’s still a better alternative to keep your variable.

If FT is at 1.65% right now and he signs up for a 4% mortgage. His variable would have to be over 6.35% (4% he can get now plus the difference between his variable and a fixed) for more than 2.5 years (half the term of the new closed).

I’m in a very similar situation but I have four years left on my term and about 220k principal left.

Switching to a fixed right now for me would cost me too much in extra interest due to my high principal amount.

But for it to even out, the bank’s prime rate would have to get to 7% from 2.5% in the next 2.5 years.

I think it makes sense but I would very much like to pay off a chunk of my principal first and then wait for the first prime rate increase.

Dalmanca brought up a interesting topic.

What should a new home buyer do who just got a 300K mortgage and 25 year amortization

dalmanca, ruff – getting a fixed mortgage is like buying an insurance policy. The extra interest rate premium is a sleep well at night cost. Personally, I wouldn’t lock in anything greater than 5 years, especially at today’s low 5 year rates. Also note that with closed mortgages, there are heavy penalties for breaking the mortgage within the term. So for a 10 year mortgage, you better be pretty sure that you’re going to be in that house for at least 10 years.

I’m on a 5 year fixed rate right now and I’m thinking about breaking and locking in at a lower rate…maybe even moving over to a 10 year fixed. One of the reasons is I’m considering implementing the SM in a year or two and would rather have a fixed rate to remove some of the risk like you pointed out.

My term is up in July, so I’ve been weighing my options lately. Fixed vs Variable. Short vs long term. Start the SM or not. Market volitility. Inflation pressure from such low rates.Where I’m at now is going for 1yr fixed over the next few years and hoping to find a prime- variable then start the SM sometime after that. I’ve got a 120 day rate hold with ING for a 1yr fixed at 3.5% in case rates go up.

What I would really like is a 1yr variable motgage with the variable heloc. Do any of you have a variable mortgage with a short term?I feel that rates will probably stay the same or go down between now and July, but I like the peace of mind of the rate hold.What do you think the rates will do short term?

Oh the decisions.

My mortgage term is up at the end of May.

$300K left on the principle.

Since I’m debating locking in for 5 years or going variable (Prime + .08 is the best I’ve been offered so far).

Is there a handy calculator out there that can help me easily decide how far prime has to go up (and how fast) over the next 5 years to make the decision?

It all depends on whether you could sleep well at night with a variable rate. With a fixed rate you know your payment and there is absolutely nothing that could change your monthly payment ( unless of course you took a loan in US Dollars and the Canadian $ depreciates)

So would nobody recommend at 10 year fixed within the next couple years? If inflation turns out to be a tenth of what some economists predict we are in store for some trouble.

i.e. Peter Schiff

For an good up to the minute forum on the current interest rates (i.e. 5-year fixed, etc.) try going to Redflagdeals. 5-year fixed are being offered as low as 3.59% for a ‘No-frills’ mortgage. CIBC is offering 3.74% for 5 years. ING – 3.95%.

http://www.redflagdeals.com/forums/showthread.php?t=351105

I just signed today with BMO for 3.85%, from my previous 5.06%. (Even after a $4840 penalty the savings is very significant). The extra few points over the lowest rates was the ‘price’ for keeping a HELOC and the same home appraisal value; such as not to pay CMHC fees with another institution.

You all make very interesting points.

Here is my take:

On a 10k investment we look to diversify it in so many ways in order to reduce the overall portfolio risk. Why don’t we look at doing the same thing with our home which is infact the largest investment that most of us will ever make. The best way to look at it is to develop a mortgage strategy that will fall in line with your needs, your lifestyle and your risk tolerance and diversify your mortgage to reduce your exposure to IRR (interest rate risk).

Here is what you should ask youself before deciding on your strategy:

1. How long do you plan on living in your home?

2. Is is important to have access to repaid principal for future projects? – Refinancing is very costly and can add several years to your mortgage so why not be prepared.

3. Are you looking for payment flexibility allowing you to pay less when cashflow is tight and pay more if you can?

4. What payment are you comfortable with and are you looking for a fixed payment or can you handle some fluctuation in payments, if so what degree?

5. What is most important to you- Save on interest or maintain stable payments or some of both?

6. Are you looking for some protection against higher interest rates in the future?

As you can see, deciding on a mortgage is not that easy, taking a low 5yr rate at 3.85% is great while it lasts however most mortgages are for 25yrs…what happens after 5yrs? what if rates increase by 1%, 2%, 3%… will you be able to afford the payment? or will you have to sacrifice your lifestyle? maybe sell your house? or you could always rack up the credit cards at 18%.

Since there are so many “what ifs” in life, we say not to time the market when investing and it goes the same for your mortgage. Don’t throw all of your eggs in one basket…remember to DIVERSIFY!

Great discussion on an interesting, real-life scenario that many of us are facing. To simplify the situation, it really comes down to mathematics, frequency and volume of future mortgage payments, and anticipation of where rates will be going. The Bank of Canada lending rate will remain depressed for some time, likely for the remainder of 2009. If you still have a significant amount of principal left to pay, and are thinking of switching over to a fixed rate, best to do it just before we leave the interest rate bottom. As opposed to now, when we are just reaching the bottom.

Of course if you have a relatively small amount left to pay on your mortgage, and plan on aggressively paying it off (as is the case with FrugalTrader), then sticking with prime-less-85-hundredths-of-a-point variable is probably the cheapest way to play it.

All the best to everyone,

InvestAssetWealth

I don’t remember if I ever posted about this here before but some time ago I created on Google Docs a quick and dirty spreadsheet to compare fixed vs. variable rate mortgage (http://spreadsheets.google.com/ccc?key=peLqod9v5EUGGfKberykfEQ&hl=en).

Basically you look at a 5 year period and you can adjust the variable rate 5 times during a 60 month period to determine which comes out ahead.

cannon_fodder,

Your memory is indeed correct!

https://www.milliondollarjourney.com/manulife-one-mortgage-review.htm#comment-37245

DAvid

Question for everyone:

I have 1.5 years left on a 379k mortgage at 5.6%. A little over a year ago i bought a new house (500k) and our rate was adjusted on my existing mortgage.

This is a horrible rate and i’ve been looking to make a switch.

I’ve been looking at Manulife One and for my lifestyle, saving and spending habits it looks to be a good choice. I like the low maintenance of the account and the current rate is 3.5%.

My question is should i switch right now? There is going to be a penatly ofcourse of approx 10-12k to get out of my existing mortgage with CIBC. I have approx 70k sitting in a savings account right now which i could use to pay down the mortgage and reduce the penatly. I realize interest rates are most likely headed higher in the next few years and i’m wondering how this might effect any changes i make?

Also, is everyone here turned off of Manulife One (and similar products)? How does one get out of a product like this if i wanted to get a traditional mortgage later and lock into some rate in anticipation of rates heading higher?

I am thoughly confused but tired of giving my money away. I am tempted to sell my Mc Mansion and rent someone else’s.

Thanks for any and all responses!

Rwfresh,

If you were to renew your mortgage today, are you sure you would want to go variable? These days, there is very little spread between variable and fixed. With variable evidently moving up in the next few years, going fixed now may save some money. FYI, I just got a quote today for 3.85, 5 year fixed, I’ve seen fixed rate quotes as low as 3.6%.

There is an extensive discussion in the M1 thread about the pros/cons of the product (https://www.milliondollarjourney.com/manulife-one-mortgage-review.htm)

Hi Frugal,

I’m not totally sure i’d want to go variable.. but the M1 product is “variable” in nature and i like how it works. Single account, interest compounded monthly, “savings” working against the principal..

Is there something that works like M1 that has a fixed rate over some term? Thanks!

rwfresh;

if you just make prepayments to a regular fixed rate mortgage, you’ll get the same effect as teh M1.

The M1 is a well marketed product. they say you can pay off your mortgage way faster than the traditional way, but that’s only true if you leave extra money in your account every month (as in spend much less than you earn). for a traditional mortgage this would be the same as making a prepayment every month or increasing your payment amount.

the actual savings associated with having your monthly expenditure money sitting in the account and saving you mortgage interest is worth under $100 a year. (ie, the $150 you had allocated for the power bill this month is put against the mortgage value until the day you have to pay the bill.)

I have been offered a discounted rate from RBC through the builed which is 1.5% lower than there regualar variable rate:

This is what they are telling me

1.75% variable for 5yrs.

Not sure if this is good as a first time buyer. But on the other hand I might be able to pay down more over the first 5 years of the term as the rates inmost cases will not rise significantly to the other offer of 4% that TD is offering.

Can anyone suggest anything.

BKS, RBC is offering a a discounted variable rate? It’s rare to see a discounted variable rate in this market, and looks like a good deal.

However, since this is your first home, at what interest rate would the payments become unaffordable? You need to decide if the chance of saving money is greater than the risk of rates going higher.

Oh, and check with a mortgage broker, I believe 5 yr rates are as low as 3.7% range today.

BKS;

make sure it’s 1.75% for the full 5 years. sometimes they have a discount for the first few months, then the discount disappears.

if you can get P-0.5% for 5 years it doens’t seem like that bad of an idea. just run the numbers as to what your payments would be if the bank prime rate was 8 or 9 %.

I am wondering if we could reduce the risk by having two mortgages with one fixed rate and one variable rate. Anyone here having two mortgages? Any pros and cons?

dalmanca;

several banks are starting to offer ‘mixed mortgages’ with both a variable and fixed component. Sorta like have two mortgages.

@ BKS, did you have to push for this? or was this just there normal offer?

The offer that I was given

was Prime -1.5% for 5yrs variable

This was the special rate that the builder had arranged with RBC.

BKS;

The largest discount off prime I have heard of is 1.0%. If you truly have Prime-1.5% variable for 5 years, I would take it as that might be the lowest mortgage rate anyone has ever had from a bank in Canada.

hey guys with the BOC saying it will keep prime at.25% atleast till the beggining of 2010 should we hold off switching until end of this year or early next year or is the risk of it going up too much thanks all for your input and knowledge

pete, it is a guessing game. I think the predominate thought is that rates will stay low for 2009, then after that, anything can happen. It really depends on when the economy recovers and how fast it catches up.

guessing games just suck – I thought we had decided to go with fixed rates for both mortgages, but leading indicators are STILL very bearish on the economy.

checked with RBC about the variable rate mortgages, and the best I could do was prime +0.6% (at least its come down by 0.2% from last time)

If you can get Prime-minus (BKS) – better lock in now.

Pete,

I think that the later you wait, the more likely that bond yields (which is, from my understanding, what banks use to base their longer term lending rates) will tend to go higher reflecting the idea that economies will recover and governments will not only reduce stimulus but will need to start applying the brakes. One way they do that is by hiking interest rates.

You can’t listen to a financial news network without daily discussions about the risk of inflation down the road because of the unprecedented stimulus. Thus, while we are enjoying historically low prime lending rates we may see much higher 5, 7 and 10 year mortgage rates 12-18 months out than we see today.

The only sure fire way to win this battle is to reduce your debt!

BKS,

Prime – 1.5 is really, really good. It’s a no-brainer provided you have enough extra income to cover the payments if the rate goes up to say 4-5% down the road. You may want to ask if get the option to convert to fixed before the term is up and at what premium.

I’ve got to say that all the notes are a great read; even better with a good cup of coffee…

FYI, I see that many peoples are asking themselves that eternal question but I wanted to let everyone know that as much as we may ask ourselves this question, most if not all of the bank managers I know have been spending 95% of their time answering that same question to inquisitive customers.

I asked a friend of mine what he was doing with that 5% left over? He said: “trying to keep the customer from going to another financial institution”…

So for everyone who these days might have a beef against banks (even as an ex bank manager, I consider myself in this pool), don’t worry, they are also feeling the heat :)

Have a great day!

BKS – your posts seem to be contradictory.

In your first post you state you are getting 1.5% LESS THAN what RBC is currently offering resulting in a current variable rate of 1.75%. This makes sense as RBC’s open variable is Prime + 1%. So your true discount is actually Prime -0.5 (still a very good rate at this time).

Current Prime = 2.25

Premium = +1

Discount = -1.5

Total rate = 1.75

In a subsequent post you state you are getting Prime -1.5%. If you can get this, I would be all over it. However, I would double check as this is a massive discount off today’s rates. I suspect that what your builder is offering is the former that they have spin doctored into what sounds like a bigger break than you are getting (though any discount off prime right now is a deal IMHO).

On an unrelated note, I was a little surprised at the large amount of mortgage principle being carried by some of the writers on this blog and I say surprised because I figured the average reader here is a cheapskate ;)

Nah, I think the average reader wishes he were as frugal as FrugalTrader. :)

hey guys with the 5 yr bond rates slowly inching up i was wondering if its time to lock in now. I am with national bank and doing the smith manuever/rempel max and my rate is prime right now and national bank indicates if i lock in for 5yrs u would get 3.95%. I know stats say u are ahead of the game if u stay variable but if it goes up even 1.75% in the next 4yrs i would be ahead of the game i think. I have about 8yrs until my mortgage/bad debt is done. any help and feedback would be great although i know no one has a crytal ball. do u think bank of canada really won’t increase the overnight rate like they said until early 2009 or is this iffy too.

I am thinking of making the switch too. Im just not sure with which 1 to take. The 3yr fixed rate @ 3.05 or the 5 yr %3.54 rate. I am planning on selling the home within 5 yrs i think but its not a certain thing. My broker says take the 5yr rate as a sort of insurance policy if i do stay the 5 yrs as rates are expected to be higher after 3 yrs and would be a bad time to come out of a 3yr then. Plus the fee should nt be so high as it would probably 3 months interest and maybe a $1599 fee as IRD wouldnt apply more then likely.

What should I do?

Any suggestions

Good discussion (albeit one month ago)…but we too are seriously, seriously starting the Smith Manouevre with our M1 account. Our FP is conducting the risk analysis, etc. right now.

The thought of rising mortgage interest rates makes me nervous. BUT if I understand the SM concept correctly, the idea of the SM is to start investing earlier than “traditional pay down debt then invest” scenario which SHOULD lead to higher compounding non-registered investment portfolio (20 years down the road minus deductible mortgage). With such philosophy, mortgage interest rates would have to skyrocket to eat away at potentially $700K to $1 M extra nest egg when starting a SM now to grow over 20 years.

Am I understanding this concept correctly? Yes mortgage interest rates are a risk to the SM but I think with the anticipated gains it would be hard to beat…plus a bigger tax refund because the interest rates are higher?! Have I overlooked the risks of rising mortgage rates?

Thanks in advance.

The fixed vs. variable spreadsheet has been moved to Canadian Money Forum.

You can find it, along with others, at:

http://canadianmoneyforum.com/showthread.php?t=897

Thank you very much, cannon_fodder. Means a lot.

Till then,

Jean