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What about variable?

What about variable?

Posted on: April 09, 2012
Author: Staff

With the current low interest rates, there's a big focus on fixed mortgages—but variable can still be a good choice.

Historically low interest rates are encouraging many Canadians to lock in with a fixed-rate mortgage. The idea is that they'll continue to benefit from the current low rate when rates inevitably rise, saving thousands on interest.

But two big questions remain: when will interest rates go up, and how much will they go up by?

  1. When will rates go up?

    According to ATB Financial economist, Will Van't Veld, interest rates will likely rise in mid-2013 or early 2014.

    "Earlier this year, the US Federal Reserve released its outlook for when it believed it would begin tightening interest rates, stating that they didn't see it happen until 2014. If this proves correct, then it limits when the Bank of Canada can raise rates because an important determinant in the value of the Canadian dollar is the interest rate differential vis-à-vis the United States," Van't Veld explains.

    "Because of the better news coming out of the United States, the latest jobs report notwithstanding, many believe that the 2014 date might be too conservative and the best bet right now is for interest rates on both sides of the border to start moving upward towards the middle of 2013."

    Recent talk from the Bank of Canada suggests rates might rise even sooner. If you commit to variable today, you would benefit from the lower rate until that rate rises above the current fixed rate for the same term. The savings you earn in the meantime could offset the higher payments you'll make after rates rise.

  2. How much will rates go up by?

    As Van't Veld explains, "if the economy is running below potential, interest rates will be kept low to stimulate growth, and if it's running too hot, rates will be increased to bring inflation back towards its target."

    In order to control inflation when coming out of a recession, Van't Veld says that "borrowers should be expecting a jump of between 1 and 3 percent in borrowing as the North American economy improves."

How could this affect your bottom line?

Using a 5-year fixed-rate mortgage of $200,000 as a baseline, here are two variable rate scenarios—one assuming a 1 percent increase over five years, the other assuming a 3 percent increase over five years:

  Starting Rate Rate after 1.5 years Rate after 2 years Rate after 3 years Rate after 4 years Average Interest Rate Balance remaining at end of term Total interest paid during term
5-year fixed 3.89% 3.89% 3.89% 3.89% 3.89% 3.89% $173,869.48 $36,483.33
5-year variable (with rates rising 1% over term) 3.20% 3.45% 3.70% 4.20% 4.20% 3.73% $173,355.72 $34,658.95
5-year variable (with rates rising 3% over term) 3.20% 3.70% 4.45% 5.20% 6.20% 4.50% $175,624.67 $41,802.94

* Based on a 25-year amortization. For illustrative purposes only.

As you can see, if rates rise moderately (1%) over the next five years, you're better off with a variable mortgage. But if rates rise significantly (3%) over that same term, locking-in at the fixed rate now will keep more money in your pocket.

Historically, homeowners with variable mortgages have enjoyed lower average interest rates—and thus paid less interest—over the long term, but this second scenario proves that it's not always the case.

It's impossible to accurately predict when and how rates will move, so your best bet is to talk to an ATB mortgage expert about your budget and risk tolerance. They can guide you in the right direction.