PETER DOLEZAL: Variable mortgage rates have lost their edge

With mortgage rates so low, borrower might want to consider a fixed rate

As 2012 unfolds, a major change in strategy has emerged for homeowners looking to secure a new or renewal mortgage.

Over the last 50 years, the variable-rate mortgage has clearly proven – at least 90 per cent of the time – to be the better alternative to the fixed-rate mortgage.

In the past, variable-rate mortgages have been on offer for as little as 1.25 per cent below prime rate. Prime rate today stands at three per cent. Having secured her renewal mortgage some four years ago, my daughter remains one of those lucky borrowers whose variable rate today continues to result in an unbelievably low interest rate of 1.75 per cent.

Until recently, choosing a variable rate over a fixed-rate option was a no-brainer. It was so clearly advantageous that most borrowers opted for it almost automatically. No longer. For the first time in many decades, the slim rate advantage of the variable-rate mortgage over the fixed-rate is no longer sufficient to compensate most borrowers, for the risk of future rate increases.

On Dec. 31, 2011, the best five-year fixed-rate mortgage offered by a B.C. bank, ING Direct, was 3.45 per cent. ING also offered the best five-year variable-rate mortgage at three per cent, an immediate rate advantage of only 0.45 per cent. The odds high that short-term rates will rise by far more than 0.45 per cent over the next five years. Given this risk, it’s hard to imagine many borrowers opting for the variable-rate option.

At the same time, the lowest variable-rate mortgage available through a B.C. mortgage broker was 2.70 per cent; the best five-year fixed-rate was 3.19 per cent. In this case the differential favoring the variable option was a comparably small 0.49 per cent.

If a borrower chooses a $100,000 mortgage, with a five-year fixed-rate at 3.19 per cent, amortized over 25 years, his monthly payment would be $483, with no risk of increases for the next five years. With the variable-rate option the borrower might initially save some $40 per month, but at the same time make himself vulnerable to significant rate increases at any time during the next five years.

Today, if I were looking for a mortgage, I would happily avoid all interest-rate risk.

I would not hesitate to find the absolute lowest five-year fixed rate, available at historically low levels.

Traditional advice for decades has been to think hard before locking in to a five-year, fixed-rate mortgage versus a variable-rate one. Today, that advice is reversed.

Think hard, before choosing a variable-rate mortgage. In most cases today, a risk-reward analysis will clearly favor the fixed-rate option.

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.