Fixed or variable, your mortgage plays a big part in financial planning

How do borrowing costs impact your debt and financial management plan?

By Private Banking 16 December 2021 5 min read

The use of debt can be a valuable tool to help you achieve your goals. In fact, wise use and management of debt can often be an effective way of building wealth over time. For example, most individuals use a mortgage to help them achieve a goal of becoming a homeowner. Often though, the “correct” use of debt and cash flow towards building wealth is not always straightforward, and financing decisions should be revisited when your personal financial situation changes, all with an eye to current interest rates. In this article, we’ll discuss planning considerations specific to mortgage financing, and other debt management tips.   

When managing your finances, it’s important to understand how borrowing fits into the bigger financial planning picture. The process of building wealth will be a product of your income, expenses, assets and liabilities. The table below illustrates the common relationships of a personal financial situation.

Source: ATB Wealth

Each area of your finances is intricately connected, and determining the most effective use of cash flow will depend on the goals and objectives for you and your family. A financial plan should assess your current financial situation, identify issues and opportunities, evaluate financial strategies, and offer recommendations to help meet your personal goals, needs and priorities.


Fixed or variable rate?

When negotiating your mortgage, you’ll need to decide whether to go with a fixed rate for the entire term of your mortgage, or a rate that varies according to fluctuations in interest rates. A variable rate is typically quoted as the prime rate, plus or minus a specified amount, such as “Prime - 0.50%.” And because the interest rate charged on your mortgage could change, it is possible that your required mortgage payment could also change accordingly. With a fixed rate, your payments are set for the entire term of your mortgage. 

Typically, the variable mortgage rate can be lower than the fixed rate for a comparable term when comparing the two options. Here are two ways to think about the difference between a variable rate versus a fixed rate:

  • With a variable rate, you get a discount—at the cost of not knowing what could happen to your rate and payment going forward.
  • With a fixed rate, you pay a premium for assurance that your rate and payment will not change, regardless of what happens to interest rates. 

Fixed-rate mortgage contracts also create more definitive terms related to interest costs. While this could be beneficial for those hoping to avoid uncertainty, you’ll likely pay a higher penalty for breaking the term early on a fixed-rate mortgage compared to that of a variable-rate mortgage. See our article on deciding whether to renew your mortgage early. If, after committing to a variable-rate mortgage, you decide that a fixed rate is more appropriate for your situation, your lender may offer an option to lock the variable rate into a fixed rate, without breaking the terms of the mortgage contract.

Deciding on either a fixed or variable mortgage rate will depend on your expectations, and comfort level with changing interest rates. For those who expect rates to remain the same, or decline over the term of the mortgage, a variable rate might make sense financially. On the other hand, perhaps you find value in the comfort of knowing that your rate is set, and what your mortgage payment will be with certainty. In either case, you should compare the two options and determine if the “premium’” for a fixed rate is worth the peace of mind as opposed to getting a “deal” with a floating rate. 


Mortgage planning

With a mortgage often taking a significant portion of cash flow, it is important to consider how your mortgage will impact your overall financial situation, and other financial goals. Making informed decisions around your home purchase and financing arrangements will help make home ownership affordable over the long term, and easier to integrate into your financial management strategy. A crucial part of financial planning considers factors in advance, which could help you save money, as well as prepare for any unexpected financial setbacks that may occur. 

Depending on your goals and objectives for home ownership, the cost of buying a home will extend beyond the initial purchase price. Ongoing property taxes, utilities, maintenance costs, and fees that could be associated with condominium ownership should also be factored into your financial analysis. When planning for your mortgage financing, consider borrowing less than your maximum qualifying amount. Qualification requirements may vary among lenders but a general rule of thumb is that your housing costs should not exceed 32 per cent of your total gross income. These costs could include your calculated mortgage payment, property taxes, utilities, and a portion of condo fees, if applicable. Another measurement may involve comparing your total total debt against gross income. Lenders might require a maximum threshold of, say, 40 per cent of gross income in order to qualify for a mortgage.

Regardless of what you may qualify for, consider what might happen if you had a change in income, increase in other expenses, or both. Could you still manage your mortgage payments in the event of financial hardship or future goals that may come up?


Other planning tips

Regardless of where you may be in your mortgage decisions, consider the following options as they relate to your overall plan and financial management strategy.

  • Consider your goals. Is your mortgage serviceable without major disruption to other goals? Is it important to you to pay off debt as soon as possible? 
  • Identify and plan ahead to determine a debt strategy. This can help minimize long-term interest costs, while balancing other goal considerations.
  • Take advantage of prepayment privileges. Many lenders allow a certain amount of additional regular and/or lump sum payments without penalty. Increasing your payment amount, even by a small amount, can make a sizable difference over the long term.
  • “Blend and extend.” If your current mortgage no longer fits your current situation, you may be able to make some changes. Some lenders may allow you to renegotiate and extend your mortgage prior to the end of your current term. A blend and extend option involves blending your old interest rate and the new term’s interest rate. This is typically considered for a fixed mortgage rate when interest rates have fallen.
  • “Port” your mortgage. If you’re buying a new home, your lender may allow you to take your existing interest rate, terms and conditions with you to your new home. This could save you from breaking your mortgage contract and the resulting penalties.

Financial management is a formal part of the financial planning framework. Your financial plan should address your personal goals, needs and priorities. Good planning should also consider other relevant financial planning areas, and the relationships between them. 

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