May 24, 2013

Variable Rate Mortgages When Rates Are Rising

The homeowners have enjoyed a long period of low interest rates. To say it has been a great ride is an understatement, however there does seem to be a trend towards increasing rates. The question is, "What should I do now?"

The prime lending rate, which is used for variable mortgages, is at 3%, with current pricing for variable mortgages below prime, ranging from 2.15% to 2.85%. I will use 2.50% for variable rates as it is close to the median. Let's compare that to the 5-year fixed rate, which is currently at 4.14%.

Currently there is a variance of approximately 1.64% between fixed and variable. So, each day, week, or month that goes by, your cost of borrowing is dramatically less. There is also the opportunity cost, which would be the difference between your payments for fixed or variable. Take for example a mortgage for $200,000 on a variable rate the payment is $897.23 per month, versus the 5 year fixed rate at $1,067.27 per month. So, what can you do with the $170 difference every month? That could cover date night and a babysitter or a couple of rounds of golf. Hmmmm.

Can rates increase and diminish the variance between the terms? Yes, they can. The questions we don't have an answer to is how long will it take to equal the fixed rate, and where will rates go.

What we do know is that there have been studies over the last 15 years which show that less interest is paid with a variable rate mortgage than a fixed rate. That being said, I still go back to the nature of the individual. What is your comfort level? Can you sleep soundly at night with a variable rate, or do you need the fixed rate?

There are other methods to reduce the principal of your mortgage without taking a variable rate mortgage, contact your local mortgage specialist to sit down and discuss your options.