Many borrowers know and understand and consequently use, variable rate mortgages today than ever before.



Dr. Milevski of York University, Toronto, conducted a study that reported that between 1950 and 2000, having a variable rate mortgage proved to be a cheaper strategy than the traditional five year fixed term strategy 88% of the time.

It is clear that this strategy, merely by its variable nature, infers a risk, but over the last years, excellent results have been achieved by assuming this risk.

Description

The interest rate on a variable rate home loan is based on the base rate of the large Canadian banks. The borrower will pay a rabais over this base rate. A variable rate loan is always quoted as the base rate less some kind of percentage.

Example: ?Base rate less 0.90%?. In this case, if the base rate is 6.00%, the client will pay 5.10% on his loan (6.00%-.90%) for the period of this base rate. A couple of months later, if the base rate is 5.25%, the loan rate will be 4.35% (5.25%-.90%) for the period of the new base rate. The Bank of Canada establishes the rate 8 times per year. This does not mean that the rate will automatically change 8 times per year, but it is possible.

Advantages

- It has been shown by studies to be the best strategy, especially in stable or falling interest rate environments.

- This strategy permits borrowers to take advantage of periods of decreasing interest rates.

- Mortgage payments are usually lower in the case of variable rate mortgages.

-?There is a lower penalty fee than with other strategies.

Disadvantages

-?The rates are variable, so they can go either up or down, adding an element of risk.

- Payments can vary with the interest rate. (It is possible not to be subject to variations n the monthly payment-see below.)

- You have to keep track of the Bank of Canada's interest rate policy and changes.

Over the long term, when should borrowers use this strategy?

It has been indicated that the variable rate policy is most often the best choice, especially if interest rates remain stable or decrease. But since we can never know for sure if interest rates are headed up or down, you have to keep close track of rate adjustments at least 8 times per year.

You can switch to a fixed rate option when you have a variable rate loan, but you have to be careful about the new fixed rate. Some lenders (your mortgage broker should be able to identify them) increase the fixed rate when the conversion option is being chosen.

This is easy to explain. When a borrower decides to convert, it is because the interest rates have increased. If there is no provision in the original engagement letter, the lender can give the borrower a high fixed rate for the fixed rate loan. This would be the highest posted rate, or the rate with a rabais. This is not the best rate that can usually be obtained. The borrower has to decide whether it is better to stay with the variable rate, or go with the higher fixed rate.

There are lenders, however, and these are the only kind we present to our clients, who are willing to promise in the loan engagement letter that upon conversion, the new fixed rate will be the best broker rate for that day. This is why it is very important to choose the right lender for your home loan.

Is it possible not to have varying payments?

The idea that the mortgage payments can increase or decrease with a variable rate mortgage makes a lot of people uncomfortable. There are two solutions:

Some lenders fix the payment and do not change it when the rate changes (in this case, it is the amortization that changes).

You can bring your initial payments up to the higher level of a fixed rate loan and then any increases in the variable interest rate will be covered. This is the solution I recommend, since you will not be increasing the balance due on the home loan.

How do you stay on top of the interest rate direction?

Since your rate will be changing with the base rate of the Bank of Canada, you have to know each time it changes. This is not difficult.

This base rate can change a maximum of 8 times per year, so it is not as if you have to keep track each day. It only happens when the Bank of Canada changes its directeur rate. This is an important news item that is announced in the newspapers, on the radio and on T.V. and on internet news.

Our clients receive an automatic notice, free of charge, via email, every time there is a change in the base rate. This way they know about any of these changes immediately when the Bank of Canada makes the change. We also provide predictions for coming months to better assist in decision making.

Option: Variable rate with a ceiling

It is possible to get a mortgage with a variable rate that has a cap on the rate. With this type of loan, if the rate keeps increasing, once the cap rate is hit, it cannot increase any further. The ceiling rate or cap rate on the loan becomes the highest rate your loan can have.

Conclusion

The variable rate strategy should be given a lot of thought. It is a strategy that can save a homeowner thousands of dollars in interest rate costs. But it is important to keep these three things in mind:

1. Make sure you choose a good lender; there are many variations to a variable rate mortgage and you want to make sure you get the best one for you.

2. Make sure you obtain a conversion option that will guarantee you the best fixed rate at conversion.

3. Stay on top interest rates or make sure that your mortgage broker stays in touch with you to advise you of changes.

Over the last fifty years, studies have shown that the variable rate mortgage strategy is the one that saves you the most money.