Before we answer that question, it’s important to understand the difference between a fixed rate mortgage and a variable rate mortgage.
Fixed rate mortgage - A fixed rate mortgage is a mortgage where the rate of interest is fixed for a specific period of time. Generally known as the mortgage term, it usually ranges from between 6 months and 25 years. As time goes on, more of the mortgage payment goes towards the principal and less of the payment goes to the interest.
Variable rate mortgage - A variable rate mortgage is a mortgage that has fixed payments, but the interest rate fluctuates with any changes in interest rates. If interest rates go down, more of the payment goes to principal and if interest rates go up, more of the payment goes towards the interest.
So, which one is better?
Determining which one is better is as simple as looking at your ability to handle risk…
Here’s an easy test…
If you loose sleep worrying about the possibility of a .25% increase in the interest rate or get stressed thinking about the impact on your monthly budget if your monthly mortgage payment changes, then a fixed rate mortgage is for you.
You should also take the same test when choosing the length of the fixed rate mortgage term. If you breath easier knowing that your mortgage payment is fixed for the next 5 years then a 5 year term is right for you.
It’s pretty simple, don’t like risk, then a fixed rate mortgage term is right for you.
Now if risk is not as much of an issue, then a variable rate mortgage is the way to go. Here’s why..
Based on a detail study completed by Moshe Arye Milevsky of interest rates from 1950 to 2000, consumers are better off, on average, financing a mortgage with a short term floating (prime) interest rate, compared to a long term fixed rate mortgage. A consumer with a $100,000 mortgage and an amortization period of 15 years would have paid $22,000 more in interest payments by borrowing and then renewing at the 5 year rate as opposed to borrowing at prime and renewing annually.
Read the full article by Moshe Arye Milevsky.
The bottom line:
Long term stability has a price, but if you can’t sleep, what goods the money?...
Suggested resources:
Mortgage Glossary – Don’t understand some of the terms used in these articles? Our mortgage glossary provides simple definitions.
Canadian Mortgage Calculator - Calculate mortgage payments, amortization schedules, interest costs and more. The more you play with it, the more you’ll see what it can do.
