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  • Fixed vs. variable mortgage: Which one is best for you?

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    Published May 14, 2012
    Fixed vs. variable mortgage: Which one is best for you?
    A fixed mortgage rate is traditionally more stable, but today's market has seen fairly low variable rates compare to a few years ago.

    As Canada stands relatively unscathed after the global financial crisis of 2009, more and more Canadians are trying to find a piece of real estate to call home. As if that isn’t a momentous-enough, the next decision involves a dreaded word in the world of personal finance — mortgage.

    When homebuyers decide to purchase a home, the next big decision involves finding the right mortgage option to make a house your own. The two primary options include a variable or fixed-rate mortgage (FRM).

    A fixed-rate mortgage is synonymous with stability. The interest rate is fixed for the mortgage’s term, which usually ranges from six months to up to 35 years. As the term progresses, more of each mortgage payment goes toward the principal and less toward the interest payment. But homebuyers can end up paying more over the long term as interest rates fluctuate.

    On the other side of the spectrum, homebuyers can choose a variable-rate mortgage (VRM). The VRM offers fixed payments, but as interest rates fluctuate, more of the payment may go toward paying down the interest and less toward the principal payment.

    So, which is better? Just like in most matters of real estate, it depends. If the homebuyer isn’t keen on taking risks, then the FRM would potentially be the better choice. The interest rate will remain stable, and homebuyers might pay a little more for that constancy. The real disadvantage here is that the rate is locked-in – homebuyers can’t reap the benefits from a fall in interest rates.

    But if risk isn’t a motivating factor, a VRM is the way to go. According to a 2001 study from York University’s Moshe Milevsky, a VRM is a better choice some 90.1 per cent of the time since 1950. His study showed Canadians saved an average of $20,000 over 15 years on a $100,000 mortgage, which makes the case for the potential long-term savings from a VRM. With a VRM, if interest rates dip, more of the monthly payment goes toward the principal and the mortgage is paid off faster.

    However, if interest rates increase, more of that same monthly payment will go toward the interest and less toward the principal. In this case, the amortization period — the time to repay the mortgage in full — is extended. But if a homebuyer has the financial flexibility to allow for some upward fluctuations in interest rates, the long-term savings might be worth the risk.

    Depending on your financial status quo and whether an upward fluctuation in interest rates will make your hair go prematurely grey, you also have the option of both. Many Canadians don’t want to place all their eggs in one financial basket, so some banks now offer an option to split your mortgage between a VRM and an FRM to get the best of both worlds. A split mortgage will benefit from any drop in interest rates while also potentially saving thousands of dollars over the life of the mortgage.

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