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Mortgage Corner: To fix or not to fix your interest rate?

Choosing a fixed or variable rate should depend on tolerance for risk as well as ability to withstand increases in mortgage payments...
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Dean Bala is a mortgage broker and Realtor working out of the Creston Valley Realty office in Creston.

The decision to choose a fixed or variable rate is not always an easy one. It should depend on your tolerance for risk as well as your ability to withstand increases in mortgage payments. You can sometimes expect a financial reward for going with the variable rate, although the precise magnitude will change depending on the economic environment. For example, this past spring you could lock in a five-year fixed rate of 2.89 per cent. The average variable rate was very close to this, so there was really no incentive to take the variable. Fast forward to now and the spread has increased. The current five-year fixed rate is around 3.6 per cent, and the average variable somewhere around 2.6 per cent. So now that there is a one per cent difference in the rate, some people may prefer to take the risk of rates going up in the future for the current savings of the variable. It really depends on each person’s risk tolerance and financial situation.

Fixed-rate mortgages often appeal to clients who want stability in their payments, manage a tight monthly budget or are generally more conservative. For example, young couples with large mortgages relative to their income might be better off opting for the peace of mind that a fixed-rate brings. Fixed-rate mortgages are generally much easier to qualify for.

A variable-rate mortgage often allows the borrower to take advantage of lower rates — the interest rate is calculated on an ongoing basis at a lenders’ prime rate minus a set percentage. For example, if the prime mortgage rate is three per cent, the holder of a prime minus 0.4 per cent mortgage would pay a 2.6 per cent variable interest rate. But if interest rates go up to four per cent, their new rate becomes 3.6 per cent. Most lenders do allow borrowers to lock in to a fixed rate during their contract, though. So if two years into a five-year variable-rate term, a borrower decided they wanted to limit their risk, they could lock into the current three-year rate with that lender. This does vary a bit from lender to lender on how exactly it is done.

Another thing to take into account is payout penalties. With a variable-rate mortgage the usual payout penalty is three months’ interest. With a fixed rate things aren’t quite as simple. It can be either three months’ interest or the interest rate differential. Again, this can vary from lender to lender, but the basics are usually the same. If the prevailing interest rate is higher than the rate you are locked in at, you will most likely just have to pay three months’ interest. But if the prevailing interest rate is lower than the rate you are locked in at, the lender is going to charge interest rate differential. This is basically the difference between the rate you are locked in at and the prevailing rate, multiplied by the length left on your term, multiplied by the size of your mortgage. Calculations for this vary from lender to lender, and can be quite complex. It is an important thing to be aware of, though, as penalties can become quite large depending on the length of time remaining, size of mortgage and amount interest rates have gone down.

As a consumer, the best option is to have a candid discussion with your mortgage professional to ensure you have a full understanding of the risks and rewards of each type of mortgage.

Dean Bala is a mortgage broker and Realtor working out of the Creston Valley Realty office in Creston. For more information, he can be reached at 250 402-3903 or dean_bala@yahoo.com.