“Will it keep you awake at night? Will you constantly be checking to see what rates doing? Do you think you might panic and lock in if rates are starting to rise?”
All of the above are questions that I ask a client before I give them my perspective on whether a fixed or a variable (adjustable) rate mortgage is right for them. I ask them these questions because I think that choosing between the two options is less of a question of which will save you more money, but more a question of a persons risk tolerance.
Think of fixed rates as a Guaranteed Investment Certificate (GIC). A GIC guarantees you a rate of return that is constant for a specified period of time. GICs are very safe, there will be no fluctuations, but do not have the potential returns that stocks do.
Stocks on the other hand are riskier, have the potential to have higher returns and losses, and fluctuate regularly. Stocks in this way are much like variable interest rates.
Over the long run, a well diversified stock portfolio usually crates substantially more wealth than GICs, however there is a lot more risk involved along with the potential for a brief diversion in strategy to cost a person thousands of dollars.When investing in stocks you are giving up security for potential returns. When investing in GICs you are giving up potential returns in exchange for security.
Taking a fixed rate mortgage is very similar to buying a GIC over a stock. You pay a premium (higher rate) in order for the security of knowing your rate will stay the same for a specified term. You don’t have to worry about your rate fluctuating or your payments changing until your mortgage comes up for renewal.
Taking a variable rate mortgage on the other hand is like buying a stock. It is very likely that your interest rate will fluctuate, there is more risk involved, but the variable rate is almost always priced lower. Much like a stock, those who stick with a variable rate strategy for the long term almost always end up saving more interest than had they taken a fixed rate.
All of the above being said, a variable rate mortgage can cause a persons payment to fluctuate, which is why many are adverse to taking them. However, one thing most people do not consider is that payments fluctuate for fixed rate mortgages as well, they just fluctuate every three or five years instead of gradually like a variable rate mortgage. This is one of the reasons I personally choose variable rates over fixed rates, because I would rather feel the payments fluctuate gradually over five years than feel the payment shock all at once in five years, while at the same time taking advantage of lower rates.
A person needs to decide for themselves if they can handle their payments fluctuating all of the time. If they cannot, then they should not be in a variable rate mortgage. Additionally, if there is any chance that you might panic and lock in out of panic the variable may not be best for you. You have to remember that when you lock in, you don’t get to lock in at what your current rate is, you have to lock in at whatever the fixed rate at the time is, which is almost always a higher rate than what your variable is at. Thinking that you can time the interest rate market is as ignorant as thinking you can time the stock market, therefore taking a variable with the intent of locking in when rates start to rise is a risky strategy. Just because variable rates haven’t moved doesn’t mean that fixed rates haven’t crept much higher. For example, prime rate hasn’t moved in the last four months, however in that same time fixed rates have increased half a percent. Those who were ignorant enough to think that they could time rates have potential cost themselves thousands because they incorrectly thought that prime rate and fixed rates move together.
Ultimately, a person needs to assess their risk tolerance and base their interest rate decision on that. After all, fixed rates are the lowest they have ever been, and as a result are a very good option for anybody who is ever a little risk averse. And for those who are on the fence, there is always the Merix 50/50 Mortgage.
What are your thoughts? Would you take a Fixed or Variable rate mortgage? Why?
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Hey Nolan,
Good article and just reinforces what I feel about the differences between fixed and variable rates.
Peter