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Morgage Strategy - Variable Mortgage Strategy (hypotheque)
By Gregory van Duyse
Variable Rate Home Loan Strategy
More and more borrowers know and understand and consequently use, variable rate mortgages today than ever before.
Between the years 1950 and 2000, a variable rate home loan was the most valuable mortgage strategy in 88% of the cases, according to a study reported by Dr. Milevski of York University of Toronto.
Anyone who enters into a variable rate mortgage should realize that there is an inherent risk because of the uncertainty of the rate. But for all of these last years, it has been shown to be an acceptable risk.
Description
The interest rate of a variable rate home loan changes with the base rate of the large Canadian banks. The lending institution does not give you a fixed rate, but rather a rabais on the base rate. This is why variable rates are expressed as a base rate less a percentage.
If the base rate, for instance, is 6.00%, and the bank quotes “base rate minus .90%”, this means that the variable rate loan will be 5.10% for the length of time that this base rate is in effect. If the base rate is lowered by the Bank of Canada, the loan rate is also lowered: a new base rate of 5.25% will mean a variable mortgage rate of 4.35% for that period. The Bank of Canada adjusts this rate 8 times per year. Note that this rate may be refixed at the same rate (no change), so the base rate does not necessarily have to change 8 times per year.
Advantages
- The variable ratestrategy has been the best choice over recent years, especially in the periods of falling or unchanging interest rates.
- This strategy allows borrowers to take advantage of periods of falling interest rates.
- Mortgage payments are usually lower in the case of variable rate mortgages.
- There is a lower penalty fee than with other loans.
- Many lenders offer this loan option.
Disadvantages
- Your mortgage rate can go up or down so there is more of a risk with this type of loan.
- Your mortgage payment amount may change up to 8 times a year. (There are ways to avoid this, however-read below.)
- You have to follow the interest rates of the Bank of Canada a few times a year.
Over the long term, when should borrowers use this strategy?
It seems clear that the variable rate is often a good choice, especially when interest rates are trending downward or are stable. Since it is difficult to know for sure if rates are going to increase or decrease, if you take a variable rate, you have to keep on eye on the direction of interest rates 8 times per year.
All of the variable rate loan products offer the option to change to a fixed rate. However, there are certain lenders (mortgage brokers can identify them) who increase the fixed rate when a borrower is converting from variable to fixed.
This is easy to explain. When a borrower decides to convert, it is because the interest rates have increased. If there is no provision in the original engagement letter, the lender can give the client a high fixed rate for the fixed rate loan. This would be the highest posted rate, or the rate with a rabais. This is not the most advantageous rate that can usually be obtained.
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The client has to decide whether it is better to stay with the variable rate, or opt for the higher fixed rate.
There are lenders who are willing to promise in the engagement letter that the best fixed rate option will be offered to the borrower. We only work with lenders who are willing to offer this promise to our clients. As you can see, it is very important to pick the right lender for your mortgage loan.
How does one avoid varying payments?
The fact that the mortgage payments can increase or decrease with a variable rate mortgage makes a lot of people uncomfortable. There are two solutions:
Some lenders fix the payment and do not adjust it when the rate changes (in this case, it is the amortization that changes).
You can raise your initial payments up to the higher level of a fixed rate loan and then any increases in the variable interest rate will be covered. This is the solution I prefer, since you will not be increasing the balance due on the home loan.
How do you stay on top of the interest rate direction?
Since your rate will be changing with the base rate of the Bank of Canada, you have to know each time it changes. This is not difficult.
The base rate can change up to 8 times per year, so it is not a number that has to be tracked every day. It changes when the Bank of Canada changes its directeur rate. This is information that is considered important business news, and is therefore announced in the newpapers, on radio and on T.V.
Our clients receive an automatic notice, free of charge, via email, each time there is a change in the base rate. This way they know about any of these changes as soon as the Bank of Canada makes the change. We also provide predictions for coming months to better assist in decision making.
Variable rate with Ceiling option
There are lending institutions that offer a ceiling on the variable rate. In other words, if the rate goes up, if you have chosen this option, you never have to be concerned about the rate going higher than a certain level. The ceiling becomes the maximum rate on your variable rate loan.
Conclusion
The variable rate strategy is an excellent strategy and should be considered by all borrowers. It can save a borrower thousands of dollars in interest rate costs. But you should follow this advice:
1. It is important to have a good lender, since there are many variations to a variable loan.
2. Pay attention to the conversion option and the new fixed you will receive at conversion.
3. Make sure you are aware of the interest rates, or your mortgage broker is going to keep you informed about them.
The last half century has shown that the variable rate home loan strategy can be the one that saves the borrower the most money. Gregory is an Accredited Mortgage Professional (AMP). To get more information on mortgage rates - taux hypothèque, please visit: Mortgages - hypothèques
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