It’s an interesting time for mortgages where the spread between variable and fixed rate mortgages are relatively small.  Right now, variable mortgage rates are in the prime + 0.8% range (3.3%) and the best 5 year fixed rate mortgage is approximately 3.95%.

With the speculation of increasing inflation, it would perhaps make the most sense to go fixed for new home buyers.  But what about those with existing variable rate mortgages?  For example, I have a discounted prime – 0.85%  (open) mortgage with about 2 years left on my term.  At today’s historically low prime rate,  I’m paying 1.65% interest on my mortgage, but where will prime be when it comes time to renew?  I’m guessing that it will most likely higher.

Here’s what Ed Rempel (CFP and CMA) thinks:

We have been recommending variable mortgages (or 1-year fixed) since the mid-90s, and there have been only a few relatively short periods where the discounted variable rate was as high as 5%.

One study I saw from a mortgage broker showed that five 1-year mortgages would have been cheaper than one 5-year mortgage 100% of the time since 1950. Variable mortgages would also have almost always saved money.

Ed is simply re iterating the fact that historically, discounted variable rates have saved money over 5 year fixed most of the time.  However, could the current situation be one of those unique times where a fixed rate mortgage would win over a discounted variable?  At least for the short time frame that I’m looking at?

Sampson had some good advice for me on the Canadian Money Forum:

FT, you would have diversification of interest rate risk though, since you are also doing the SM – and you could obviously increase your HELOC amount if rates remain low. Not as good as your Prime-minus – but still below 4%.

It’s a good point that all of my debt is variable, and getting a portion of my debt as low rate fixed may be a wise move.

Even though I’m typically a big believer in discounted variable rates, here’s why I am leaning towards taking the fixed rate:

  1. Variable and fixed rates are near historic lows which leads me to believe that they will move up from here.
  2. My current mortgage is open, thus no penalties to switch.
  3. High inflation is potentially on the horizon, thus a higher prime rate.  To put this in perspective, 6% prime is the historic norm.
  4. My mortgage is fairly small (~$75k) (interest diversification) and I plan to pay it off completely over the next 5 years.

The reasons why I’m hesitant to switch:

  1. My variable rate is currently much lower than the fixed rate offered (1.65% vs 3.95%).  This equates to about a $100/month payment difference.
  2. Economy looks like it will stay depressed for 2009, which will most likely mean that prime rate will remain low in the short term.
  3. Really can’t predict where rates are going to be in 2 years.  Discounted variable rates may be available again and inflation may not be as aggressive as predicted.
  4. If we were to get aggressive in our mortgage pay off, it may be possible to pay off our mortgage completely before the term is up.

So what do you think?  Any of you with discounted variable mortgages looking at switching to fixed rate soon?

53 Comments

  1. LisainSK on June 22, 2009 at 3:09 pm

    Good discussion (albeit one month ago)…but we too are seriously, seriously starting the Smith Manouevre with our M1 account. Our FP is conducting the risk analysis, etc. right now.

    The thought of rising mortgage interest rates makes me nervous. BUT if I understand the SM concept correctly, the idea of the SM is to start investing earlier than “traditional pay down debt then invest” scenario which SHOULD lead to higher compounding non-registered investment portfolio (20 years down the road minus deductible mortgage). With such philosophy, mortgage interest rates would have to skyrocket to eat away at potentially $700K to $1 M extra nest egg when starting a SM now to grow over 20 years.

    Am I understanding this concept correctly? Yes mortgage interest rates are a risk to the SM but I think with the anticipated gains it would be hard to beat…plus a bigger tax refund because the interest rates are higher?! Have I overlooked the risks of rising mortgage rates?

    Thanks in advance.

  2. cannon_fodder on August 23, 2009 at 7:44 pm

    The fixed vs. variable spreadsheet has been moved to Canadian Money Forum.

    You can find it, along with others, at:

    http://canadianmoneyforum.com/showthread.php?t=897

  3. used tires on April 25, 2010 at 6:49 am

    Thank you very much, cannon_fodder. Means a lot.

    Till then,

    Jean

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