When we bought our first home a couple of years ago, we naturally had a lot of questions about how this whole process worked. I had been doing a fair bit of research on the housing market in Vancouver and I was trying to educate myself as best I could, but there was always the question of whether we should choose a variable rate mortgage or a fixed rate mortgage. In the end, we decided on quite a flexible variable rate mortgage. Let me explain why.
A Little Bit of Background
Let me preface this by saying that I am only speaking from my own personal experience and your own situation could call for a different solution altogether. For us, having the lowest possible mortgage rate was certainly an important factor to consider, but we also wanted a mortgage that allowed for some flexibility. We wanted the opportunity to toss in an extra lump sum payment if we could, for example. In the end, we figured that a standard five-year term with a 25-year amortization would be reasonably suitable.
It’s important to shop around for your mortgage, just as you would shop around for anything else, but we wanted to have a little guidance too. For that, we turned to Kristin Woolard, a mortgage broker from Dominion Lending Centres. What’s great is that we didn’t have to pay her anything to do the shopping around for us, because she gets compensated by the banks and lending companies for sending them business.
Saving Money Now and Later
One of the main arguments for choosing a variable rate mortgage is that your effective interest rate is generally a good amount lower than the equivalent fixed rate mortgage. This means that you pay less interest and you can pay down your principal more quickly. However, with many variable rate mortgages, your monthly payment can fluctuate based on the interest rate of the day. If there’s a sudden jump in the rate, then your payment can increase accordingly and you may find yourself in quite the budget crunch.
On the flip side, you have fixed rate mortgages where the rate stays the same throughout your term, so your monthly payment also remains the same. This provides a far greater sense of stability, but it comes at the expense of a higher interest rate. That being said, if interest rates do increase over the course of your term, it might actually work out cheaper to have a fixed rate mortgage. It’s a gamble.
But we decided on a variable rate, because we figured that the rate wouldn’t increase so much over the course of the five-year term as to nullify our savings. Even if the prime rate increased about two percent, we’d still be no worse off. What this meant is that we save money now, insofar as we pay less interest along the way, and we save money later, because we’d be paying down our principal more quickly.
Retaining the Predictability of a Fixed Rate Mortgage
As it turned out, Kristin was able to get us quite the great mortgage through Coast Capital Savings. It was a variable rate mortgage, but it worked in a slightly different way. Rather than having the monthly payment fluctuate with the prevailing interest rate, the dollar amount would remain constant. What happened instead is that the distribution of that payment, between interest and principal, would fluctuate accordingly.
In this way, we effectively gained the predictability and stability of a fixed rate mortgage (assuming that the rate didn’t increase so much that the interest component would exceed the established monthly payment amount), but we were also able to take advantage of the lower variable rate too. It was a win-win.
What’s more, the mortgage allowed for a lot of flexibility, including lump sum payments at any time, (up to) doubling our monthly payment, and the ability to “skip” a payment if we were hit with an unexpected and expensive surprise. We didn’t feel we needed mortgage insurance for these reasons, among others.
Home Ownership Isn’t for Everyone
At this point, we’re almost halfway through our five-year term and our interest rate has remained steady the whole time. Yes, we’ve paid quite a bit of interest along the way, but such is the nature of home ownership and mortgages. This is one of the many reasons why home ownership may not be for everyone, but I’d say it’s working out for us thus far.
If you’re in the market for a mortgage (or a new home), I recommend that you find a mortgage broker you can trust and heed their advice. I am no in way associated with Dominion Lending or Coast Capital, so I’m not necessarily saying that you should go with either. What I am saying is that it pays to do your homework, as this whole mortgage and home-buying business can be quite overwhelming.