Tuesday, February 9, 2010

Variable or Fixed...what is the best option?

This is a question I hear A LOT. The answer is that there's no one-size-fits all solution — the ideal mortgage depends largely on your individual circumstances and risk tolerance.

A recent study found that 88 per cent of Canadian mortgage holders saved money by sticking with a variable rate over the past 10 years. But 68 per cent of Canadian homeowners have fixed-rate mortgages. Does this make sense to you because it sure doesn’t make sense to me. If there is historical data that proves one option performs better than the other, isn’t the choice logical?

I believe the biggest reason why the greater percentage of consumers have fixed rate mortgages, is conditioning. We’ve been conditioned by our parents to be conservative with our finances, especially mortgages and we’ve been conditioned by the banks to always look first at fixed rates.

I’ll start with parental conditioning, which has two elements. The first is that by and large, our parents (those that are 60+) were very conservative with their finances and that, if anything, is what they taught us. Now, it’s not their “fault” because that’s what was taught to them by their parents. These are people that lived through World Wars and the Depression, how could they not be conservative and how could that not trickle through the generations? My parents only ever had one mortgage (with a bank) and it was a 30-year mortgage. So, with all that experience, what sort of wisdom do you think they would have to impart on my first step into purchasing a home...go to the bank, the second element in parental conditioning that leads nicely into how consumers are conditioned by the banks.

Hopefully the way I refer to banks in this blog doesn’t lead people to believe I think banks are completely evil and that everyone that works for them are incompetent. On the contrary, I know a lot of people who work at banks and are very good at what they do. When I speak of banks, I’m talking in general and about the truths that I believe make up most of their practices. Having said that, go into a bank and ask them what their mortgage rates are and I’m willing to bet that a very high percentage of the time the first rate they will tell you is their 5-year fixed rate. Why? Is it because that’s the term and option they profit the most on, is it because it’s considered long-term and they know they have you stuck with them for 5 years or is it because that’s just the rate most people ask for so it’s the one they generally lead with? I believe it’s a combination of a lot of things. You can sort of see how it could just be a vicious cycle...we’re conditioned to go to the banks and they’re conditioned to lead with the 5-yr rate. Reality is the banks are in business to make money so they’re going to try to profit from you however they can, whether it’s through selling you their most profitable product or gouging you with high rates. My biased opinion is a mortgage agent is always a better option. We don’t profit from you, we’re paid by the institution we place your business with. Our role is to find you the best product at the best rate. My goal is a satisfied client, who I hope will come to me when it’s time to negotiate their renewal and refer me to the people they know. The banks don’t typically care if you threaten to leave them because they know that at the very same time, someone is threatening to leave the bank next door and will walk right in through their doors. I get that banks for some reason make people more comfortable and that’s fine, all I’m saying is if you choose the bank route, make sure they present you with ALL of the options and not just the 5-yr fixed rate.

On to the question of variable or fixed. Typically when I’m asked the question my answer is that it’s a matter of personal preference and tolerance. Then the follow-up question is what do I have. I usually hesitate to answer that question in fear it be perceived as advice. My role as a mortgage agent is to present all of the options, pros and cons and let clients make the decision that’s best for them. What I think is best for me and my family might not be best for you and yours. What I usually tell people is that it comes down to what will help you sleep at night. If you’re going to be completely stressed with a variable rate mortgage and will stay up worrying about it, then it’s not for you. If you feel easier with the idea of knowing what your payments are going to be for the next 5 years even though you MAY pay more in interest over that term than if you took a variable mortgage, then that’s the best option for you. A comparison I like to draw is with your investment portfolio. Is your portfolio mostly comprised of GICs, Canada Savings Bonds (like my parents advised me to invest in) or low-risk mutual funds? Then more than likely a fixed rate mortgage would be best for you. Do you hold mostly higher risk equity mutual funds or stocks? Then more than likely your risk tolerance would mean you can handle a variable mortgage.

The answer to the question of what I have is variable. It’s what works best for me and my family. Obviously I like the fact that variable rates are much lower than fixed rates at this time. Currently a 3-yr variable is as low as 1.85% whereas a 5-yr fixed is at 3.64%, which is still a fantastic rate. One of the things I prefer about variable rate mortgages is the flexibility. If for whatever reason I decide variable is not for me, I’d be able to lock into a fixed rate with no penalties. If I decide to refinance in order to consolidate debt, remove equity for renos or just take advantage of a lower rate relative to Prime, the penalty to do so, is a fraction of what the penalties are to break a fixed-rate penalty. Here’s an example, I recently had two clients looking to refinance, one had a fixed rate mortgage and the other had a variable rate mortgage. For the fixed rate client, the new mortgage rate would be almost 2% lower than what they were currently paying but with a $10,000+ penalty to break the mortgage, it didn’t make sense to do it. On the other hand, the variable rate client was paying Prime + 0.60% (2.85%) and by breaking their mortgage in favour of paying the going rate of Prime – 0.40 (1.85%), although they had to pay a $2500 penalty to do so, they stand to save $8500+ over the next three years.

If you want to talk about your own situation and what works best for you, I’d be more than happy to show you all of your options.

peter@theabbatangelogroup.com
647-203-5440

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