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Are Variable Rate Mortgages Really That Risky?

The 5-year fixed rate mortgage product still remains the front-runner in Canadian mortgage choices for consumers, but you may have found yourself interested in those lower variable rates that you always see advertised.  As is human nature, most shy away from variable rate mortgages simply from fear of the unknown.  The big question most ask themselves is: “What if rates rise?”

What If Rates Rise?

Great question, but a pretty simple answer.  If rates rise, then you will ultimately pay more in interest over the course of your mortgage term.  Most variable mortgages are calculated with a bit of “wiggle room” to account for situations where interest rates rise moderately.  In many cases, as long as interest rates do not rise significantly, your mortgage payment will remain constant.

What If Rates Fall?

Another great question and yet, still a simple answer.  If rates fall, you will pay less in interest over the course of your mortgage term.  In most cases, your payment will not decrease and the extra interest savings will be applied to your outstanding principal balance.  If rates fall dramatically for a good portion of your mortgage term, you will benefit by paying off your home in less time than you originally amortized.

Don’t Overlook Benefits of a Variable Rate Mortgage

Most consumers overlook the immediate benefits of choosing a variable rate mortgage for their next home purchase financing or renewal.  From day one, you will be saving interest on your mortgage payments with a variable rate mortgage when compared to a 5-year fixed rate.

Consider the rates offered by Home Mortgage Ontario as I write this post:

5-Year Fixed 5-Year Variable
3.14% 2.80% (Prime -0.20%)

Currently, the Bank of Canada prime interest rate is 3.00% and has been since September 2010.  Economists have been suggesting that the prime rate will be increasing for quite some time, but the economy hasn’t allowed for it.  At this point, speculators suggest that at the end of 2012, we should expect a rate hike.

Does a Potential Rate Increase Encourage a Fixed Rate?

One should be aware that historically, increases to the prime rate by the Bank of Canada occur in 25 basis-point (bps) increments.  In other words, if we were to experience an interest rate increase by the end of 2012, we could expect the rate to be increased to 3.25%.

Even with a potential increase, with variable rates at prime -0.20%, a variable rate would continue to offer savings over a 5-year fixed rate.  While the rate could continue to rise in 2013, most expect a single increase in the foreseeable future.

Wait!  Can’t Forget Best Case Scenarios!

While rates have been so low for so long, you must also consider that rates could drop back down to the lows we experienced from March 2009 to August 2010!  In which case, you would save even more interest over the 5-year fixed at current rates.

Yes – There Are Risks…

This blog post is intended to keep you open and informed of the different mortgage options available to you in the current financial climate, not to suggest that a variable rate is right for you.  With fluctuating interest rates in a variable mortgage, you must ensure that you can financially withstand the situation in which interest rates do rise.  Most mortgage brokers, myself included, are hesitant to suggest a variable rate mortgage because of the potential risks.  Gaining knowledge about variable rate mortgages is the only way to ensure that you can be confident that the risks are worth the rewards.

Contact Home Mortgage Ontario, your variable rate mortgage specialist, to discuss your risk tolerance for fluctuations and determine whether a variable rate is a benefit to your financial plan!

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