October 11, 2011

To Lock or Not

Is this the time to lock in your mortgage interest rate? Should you choose a fixed or variable rate? Kevin Lutz looks at the options.

Kevin Lutz, regional manager, mortgage specialists, Royal Bank of Canada

A few years ago, it was clear that going with a variable rate mortgage could result in savings. Now, discounts on fixed rate mortgages and the narrowing spread between short-term and longterm interest rates have made the choice less obvious. You can choose to go with a stable, less flexible fixed rate mortgage, or you may feel more comfortable with the risks and potential rewards of a variable rate mortgage. For the “best of both worlds” you might decide on a mortgage that combines both. It really depends on your tolerance for risk, as well as your current goals and life stage. Here is some information about each option to help you make the right choice.

The case for fixed rate
Fixed mortgage rates are currently at historic lows with some rate offers even near the bank’s prime rate. A fixed rate mortgage is chosen most frequently because of its high level of stability, providing a locked-in rate during the entire term – say, for example, five years. This means you’ll know exactly how much principal and interest you will be paying on each regular mortgage payment throughout the five years of your term. The down side is that you can’t take advantage of a lower interest rate – and the ability to have more of your payment go towards the principal and less to interest – if interest rates drop during the term of your mortgage. Summary: Fixed is for you if you enjoy the security of a rate that is guaranteed not to change for the term of the mortgage and you are willing to pay a slightly higher interest rate for that security. Fixed rates are at historic lows.

The case for variable rate
It is no secret that many economists are saying that interest rates will remain stable for some time. Stable (and low) interest rates bode well for people considering a variable rate mortgage. Typically, variable rates include some of the lowest rates available. While there is always a risk of interest rate fluctuations, this concern may be less of a factor than you may think, and there are other reasons to consider a variable rate mortgage. Many Canadian economic experts believe that a mortgage rate that varies with fluctuations in the bank prime rate will offer the greatest advantage when it comes to long-term savings on interest costs. Here are some variable rate payment details to help you decide: Regular mortgage payments are set for the term, even though interest rates may fluctuate during that time. When rates go down, an increased amount of your payment goes towards paying the principal. With more going into your principal, the less interest you pay, and the faster the mortgage is paid off. When rates go up, you’ll see an increase in the portion of your payment that goes towards paying the interest. With less going into the principal, the amortization period is extended. Summary: Choose a variable rate if you are comfortable with rate fluctuations to gain possible long-term interest savings. You have the flexibility to accept possible increases in your amortization should the interest rate increase.

The case for both: fixed and variable rates in one mortgage
Many lenders, including RBC, offer mortgages that can “hold” a combination of both fixed and variable terms. You can split your mortgage between fixed and variable rates with different terms and maturities in order to benefit from potential interest savings and the security of a predictable rate. Whether rates remain stable or fluctuate, this strategy reduces the risk of making a bad decision and could save you thousands of dollars in interest costs over the life of your mortgage. Note: most lenders require somewhat of a larger down payment for this product.

Choose a combination mortgage if you are concerned about future interest rates and want to enjoy the security of a fixed rate, but still want the potential long-term savings of a variable rate mortgage. You need to have sufficient equity in your home or a larger down payment to choose this option.

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