The mortgage dilemma

Fixed or variable, the choice is not always a simple one

Canadian mortgage holders have been fortunate for the past several years. The long-anticipated increase in rates has failed to materialize. Today in fact, not only mortgage brokers, but also banks and credit unions are advertising five-year fixed rates as low as 3.65 per cent — near historical lows.

The delay in rate increases has been largely the result of the market and financial tsunami of 2008 and 2009. To avoid an even worse financial and economic crisis, bankers world-wide had no choice but to hold rates at extremely low levels.

Unfortunately for mortgage holders, the low-interest hiatus is about to end. U.S. and Canadian government stimuli are at an end. Economies, though not yet booming, show signs of solid recovery — especially in Canada. Central bankers are beginning to show concern for inflation — a sure sign of imminent rate increases. Bond market interest rates, which drive mortgage rates, are virtually certain to follow suit.

As a result, the Canadian looking in the next few months for either a new mortgage or to renew an existing one, has a somewhat confusing choice to make. On the one hand, five-year variable-rate mortgages are currently available for as low as 2.1 per cent. On the other hand, a five-year fixed mortgage is available at a very attractive 3.65 per cent.

A recent survey by CIBC found that 39 per cent of respondents would currently choose a fixed-rate mortgage; 32 per cent would opt for the variable rate; and 25 per cent were undecided.

Why is the decision so difficult? The rate differential between the two options is the lowest it has been in many decades. It remains a fact that over the past 50 years a borrower would have saved money 89 per cent of the time by holding variable mortgages. However, the rate differential was never this low, with a thundercloud of imminent rate increases on the horizon.

Personally, I continue to favour the variable option. I believe rate increases will not be drastic, nor frequent — an approach which would jeopardize the nascent Canadian recovery. However, for a homeowner with a large mortgage and little budget flexibility, the certainty of a fixed rate may well be the prudent choice.

There is an approach which may provide a comfortable middle ground, thereby solving the dilemma for those undecided on the best option. Various financial institutions and mortgage brokers now offer a blended solution, with half the mortgage amount locked in at the low fixed rate, and the other half at the lower variable rate.

As of early June for example, Coast Capital Credit Union offered a five-year fixed mortgage at 3.65 per cent, a variable mortgage at 2.1 per cent, and a blended mortgage rate of 2.85 per cent.

If you prefer the lower rate of the variable solution, but fear the considerable risk of rate increases, consider the blended  rate option. With that choice, you get the best of both alternatives, with only half the risk of solely a variable solution.

Regardless of the eventual choice of mortgage type, it’s very clear that with rising rates looming, a future mortgage holder will be well-advised to make as many extra, or higher regular payments as possible, in order to pay off the loan as quickly as possible. In so doing, he will often save tens of thousands of dollars in interest costs, compared to the costs incurred with a 25 or 30 year amortization.

A retired corporate executive, enjoying post-retirement as a financial consultant, Peter Dolezal is the author of three books. His most recent, The Smart Canadian Wealth-Builder, is now available at Tanner’s Books, and in other bookstores.