Exploring the Pros and Cons of a Variable Mortgage Rate

After years of preparation, you are now in a position to purchase a home. How will you go about financing the purchase? Some people prefer to go with a fixed rate mortgage versus one of the variable rate products on the market today. Before you assume one is automatically better than the other, it pays to look closely at the advantages and drawbacks associated with each one. Here are some things you should know about going with a variable mortgage rate and when it’s the best choice.

Exploring the Pros and Cons of a Variable Mortgage Rate

Enjoy the Benefits of an Initial Fixed Term

Variable rate mortgages can be structured in one of two ways. One is known as an open variable product. What this means is that the debtor has the option of converting to a fixed rate at any time. The second approach is a variable rate mortgage that includes a specified fixed term at the front end. As you look at each one, make a note of what your choice could to do help or harm your financial situation.

Variable open mortgages can be paid at any time, without any penalty, but come with a higher rate. Normally around 5%, since the client is not making any time commitment as to how long the mortgage will stay with the bank.

Variable closed mortgages have a much better rate, but the client has to agree to keep the mortgage with the bank for a specific term.

Both options allow the client to switch to a fixed rate at any time, at whatever the market fixed rates are at that time.

Some people choose open rate variable mortgages because they want to be prepared for any fluctuations that may occur with the prime rate. For example, they may notice that the prime rate is dropping and market experts are predicting that they will remain at the lower level for the next decade. This may prompt the homeowner to convert to a fixed rate in order to lock in the perceived benefits of that type of mortgage.

Keep in mind that once the conversion is done, there is no going back to that open rate variable mortgage. Should the prime rate drop more than predicted, that new fixed rate may not seem so attractive.

Another factor to consider is known as the posted fixed rate. This may be the fixed rate that individuals first hear about when they inquire about the current prime rate. In fact, there may be a fixed rate out there that is lower. Just because you hear about a posted rate of 5.50%, don’t assume anything.

Be Positioned to Take Advantage of Reductions in the Prime Rate

Should you choose to secure a fixed rate mortgage, that rate will apply for the duration of the mortgage contract. Whether the prime rate increases or decreases will have no impact on the amount you repay to the lender. That’s great if the prime rate does increase as the years pass, but it can sting a bit if the rate drops well below what you are currently paying.

When the options are evaluated based on what has taken place in the real estate market in Mississauga and other major Canadian cities over the last decade, it pays to be poised to make the most of the current trend. Taking out a variable rate mortgage with a relatively short honeymoon period would position you to take advantage of further decreases in the prime rate.

Paying Less Interest Over the Life of the Mortgage

There is definitely the potential to pay less interest over the life of your mortgage by choosing a variable rate. In order to get the most out of the arrangement, you do need to monitor what is happening in the market and be prepared to make a change if the circumstances warrant such an action. This means if the prime rate increases and the predictions indicate the rise will continue for several years, it’s time to exercise your right to convert and lock in a lower fixed rate now.

Weighing the Risks and the Potential Rewards

It’s true that you do assume some risk by choosing a mortgage with a variable rate. There are ways to create a buffer and keep that risk within reason. One approach has to do with where you set that initial variable rate.

Only you can decide if a variable rate is better for you than a fixed one. Work with a professional to explore different scenarios and settle on the one that seems to be best. The right choice will ultimately save a lot of money and maybe even help you retire the debt sooner rather than later.

At Sam McDadi Real Estate, we work with our clients to ensure they are receiving the very best mortgage services. Contact us at 905-502-1500 for more information.