When dealing with Variable Rate Mortgages (VRM), the idea of a “set payment” plan is not the intent. The intent is to “float” an interest rate according to what the prime rate of Canada is doing. Canada’s prime rate is currently sitting at 3.00%. All variable rates will be at prime, above (premium) or below (discounted). For example, if contract states that you are at prime – 0.35%, your current rate is 2.65%. The fluctuation will be due to changes in prime. That being said, regarless of what happens to the prime rate, you will always be prime – 0.35%. Therefore, if prime goes up to 4.00% your rate will be 3.65%. If prime drops to 2.00%, your rate will be 1.65%.
We know that with experiencing historically low interest rates, a VRM has very beneficial factors. A variable rate can be easily justified in today’s market. The common variable rate mortgage has an interest rate that floats under the prime rate of Canada. Herein lies the question; “why isn’t EVERYONE taking a variable rate mortgage?” Seems simple enough, the prime rate of Canada stays low, and my interest payments stay low as well. Well, the truth of the matter is that there is no guarantee that we will stay at these “all time lows” with interest rates. However, all hope in security is not lost when choosing this type of mortgage. The lenders have a “lock in” feature set up within the program that allows you to lock into their fixed rate mortgage at any time, without penalty.
What about prepayment options and prepayment penalties? In most cases, we can find a bank that will allow prepayment options attached to their variable rate products. If you decided to set your payments to reflect a higher interest rate, the difference between the two payments goes directly to your principle each month. That’s even better. That has potential to save you YEARS off the amortization on the mortgage.
For example, imagine that your payment is suppose to be $1,250. You can increase your payment to $1,500. The additional $250 per month goes directly to capital and no interest is taken from the additional amount allowing you to pay off your home sooner.
The prepayment penalty of a variable rate mortgage (breaking the mortgage), is always a three-month interest rate penalty regardless if you break your term after 5 months or 50 months.
A fixed rate mortgage, or commonly referred to as a “closed” mortgage, is set up so that you have “fixed” payments at every month (or bi-weekly, etc.). There is no guessing as to what your next mortgage payment is going to be from month to month.
Let’s say you have a $250,000 mortgage and you have an interest rate of 2.99% over a 5 year fixed term. You know that if you pay the minimum payment per month, your payments will be $1,181.31(principle and interest only) for the next five years. That’s the security of having a fixed rate. This type of mortgage may be most attractive for the client who has a set income; example a pensioner, or a disability fixed income, or even a first time homebuyer that desires security in newfound ownership. The fixed rate mortgage is designed for security in knowing payment structure, and peace of mind.
As far as deciding what’s best for YOU, there’s no right or wrong answer! It all depends on a risk and security factor that you’re comfortable with. Everyone has their own idea of “how to get ahead of the game”, and how their monthly finances work within their household. Talking to us just may help you find the right strategy for your needs in YOUR game.