Mortgage Rates: Which one is right for you? Why does the decision seem difficult to make, or is it? This question has been asked by many mortgage consumers, and it has been answered by many financial experts in a general way - that you'll save more interest cost with variable rate mortgage than fixed rate mortgage. Their answers are correct and fact based, but do not go far enough with information to empower and help consumers make the decision that is right for them. There are also empirical studies to prove that variable rate mortgage is the better choice. Most notable Canadian study is by Dr. Moshe Milevsky's research report titled Mortgage Financing: Floating Your Way to Prosperity. "I provide detailed evidence that Canadian consumers are better off, on average, financing a mortgage with a short-term floating (prime) interest rate, compared to a long-term fixed rate," was the first sentence of his report.
With such conclusive evidence to support the benefits of variable rate mortgage over long term fixed rate, then why isn't there more average Canadian mortgage consumers taking advantage of a variable rate mortgage more often? There may be many reasons, but the blogs and comments from past and present on this topic matter suggest a common underlying theme: mortgage consumers are just uncertain which choice to choose.
I believe this uncertainty results from the lack of cohesive market information and interest rate decision-making tools for the mortgage consumers.
Here is why I say that This is important and relevant to our discussion here. Lets quickly look at the flip side of borrowing, investing. Your investment portfolio is guided by a fundamental principle of investing - Know Your Client (KYC). KYC is the term formally known in the investment industry. Before you put money into any investment (mutual funds, bonds, or equities, etc.) that are exposed to any potential market fluctuations, your investment advisor or investment brokerage company completes a KYC with you; and this renews on an annual basis. This KYC is a powerful investment decision-making tool that helps your advisor assess and understand your risk tolerance level and what investments are compatible within the spirit of your KYC. This also helps to set an investment plan and goal for you. More importantly, the KYC helps you understand, in your current situation, what type of investor you are: Conservative or Risk Adverse, Balanced, or Risk Tolerant. Your risk tolerance level largely dictates your investment selection. Investments with lower risk level (conservative) such as bonds, debentures, and other debt instruments tend to provide lower returns and higher risk level (risk tolerant) such as equities and derivatives will potentially have higher returns; risk versus reward. The potential opportunity gain or loss is supported by your KYC. With this fundamental understanding, Canadian investors have placed significant sums of their investment portfolio into investments that are exposed to market fluctuations in Canada and abroad. During times of economic uncertainty and large market fluctuations, the majority (if not nearly 100%) of investors do not panic and sell off their investment positions and go into fixed investments like Guaranteed Investment Certificates (GIC's). They stay the course. Why? Because there are ample market information to support the fundamental understanding by the investing public that their investments would be subject to market fluctuations. Furthermore, investors have a good understanding of their own risk tolerance level, which brings comfort and confidence that, the plan and goal they have set out is for long term.
Could the Know Your Client (KYC) or some similar form apply to the mortgage borrower and help with interest rate decision-making? There are similarities of disclosure that could help the mortgage consumer understand the fundamental nature of variable rate mortgage and how interest rate (prime rate) moves. More importantly, there are similarities that could help mortgage consumers understand what type of mortgage investor they are relative to their current situation: Conservative or Risk Adverse, Balanced, or Risk Tolerant. For example, if you are a Conservative mortgage consumer, you would most likely select a fixed rate mortgage. The 5 year fixed rate is the popular choice most Canadians would choose because they would know the exact monthly payment, total interest cost and principal balance outstanding at the end of the 5 year term. If you are a Risk Tolerant mortgage consumer, then the variable rate might be a possible choice. It offers the lowest market interest rate one could obtain but your interest rate, total interest cost and principal balance outstanding is unknown until the end of your variable term. In addition, your mortgage payment may fluctuate with the movement of interest rate during the mortgage term. If you are a Balanced mortgage consumer you prefer to lock-in a portion of your mortgage in fixed rates and take advantage of even lower variable rates for the other portion, in this case a hybrid mortgage (split mortgage) might be the product for you.
Now lets see what mortgage consumer type you are.
Mortgage Customer Type: Conservative, Balanced, or Risk Tolerant. Which type are you?
Conservative
- Prefer certainty on mortgage
- Meet new qualifying rules
- First Time Home Buyer
- Limited budget for payment increase
- Minimal equity in property
- Need to know exact monthly payment, interest rate & interest cost & principal balance outstanding at maturity
- Concerned with rate increase
- Pay higher rate for long term mortgage stability
- No plans to sell in next 5 years
- Candidate for 4 - 7 years fixed rate
Balanced
- Prefer best of both worlds: variable and fixed rates
- Some equity in property
- Monthly budget not stressed
- Could tolerate fluctuation on some portion of mortgage: monthly payment, interest rate, & interest costs
- May sell within 3 years
- Short term plans with property
- Candidate for short term fixed rates, variable rate with fixed rate conversion option, Hybrid or split mortgage
- Fixed rates 1 - 3 years
Risk Tolerant
- Prefer lowest market rate
- Could tolerate interest rate fluctuation
- Monthly budget not stressed
- Prepared for potential monthly payment increase
- Understands long term savings with variable over fixed rate
- May sell within 1 year
- Short term plans require mortgage flexibility
- Rate instability for potential higher interest cost savings
- Candidate for variable closed or open, could convert to fixed rate anytime
- Variable rate mortgage or short term fixed rate 6 mos - 1 year.
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