Morgage Strategy - Variable Mortgage Strategy (hypotheque)

By Author: Gregory van Duyse
Total Articles: 9
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Variable Rate Mortgage Strategy

Many borrowers know and understand and consequently use, variable rate mortgages today than ever before.

A report by Dr. Milevski (York University, Toronto) reveals that between 1950 and 2000, variable rates were less expensive than the 5 by 5 strategy (five years fixed) 88% of the time.

Of course, a variable rate strategy includes some risk, just by its nature of being variable. But the last half century has shown that it has been a risk well work taking.

Description

Interest rates on variable rate mortgages are based on the base rate of the large banks in Canada. The rate a borrower receives is a rabais over this base bank rate. Variable rate loans are always quoted as a base rate less a certain percentage.

Example: Base rate less 0.90%. In this case, if the base rate is 6.00%, the borrower will pay 5.10% on his loan (6.00%-.90%) for the period of this base rate. A couple of months later, if the base rate is 5.25%, the loan rate will be 4.35% (5.25%-.90%) for the period of the new base rate. The Bank of Canada establishes the rate 8 times per year. ...
... This does not mean that the rate will automatically change 8 times per year, but it is possible.

Advantages

- It has been shown by studies to be the best strategy, especially in stable or falling interest rate environments.
- It permits one to take advantage of falling rates during the period of the mortgage.
- Home loan payments are usually lower in the case of variable rate mortgages.
- This option is offered by a lot of lenders.

Disadvantages

- The rates are variable, so they can go either up or down, adding a risk factor.
- Payments can vary with the interest rate. (It is possible not to be subject to variations n your mortgage payment-see below.)
- You have to be awareof when the Bank of Canada is changing its base rate, so you can decide what to do with your home loan.

When to Use this Strategy for the Long Term

It has been shown that the variable rate policy is most often the best choice, especially if interest rates remain stable or decrease. But since we can never know for sure if interest rates are headed up or down, you have to keep close track of the changing rates at least 8 times per year.

Since all of the products that offer a variable rate also offer the possibility of converting to a fixed rate, certain lenders are known (by the mortgage brokers) to raise the fixed rate that they will offer when a borrower is converting.

Here is the reason. If a client wants to convert, it is because the rates have increased. The bank gives him the option of converting, but the rate he will receive on the day he converts is not covered in the mortgage engagement letter. The bank therefore gives him the posted rate or a rate with a small rabais, but not the best rate that it offers to brokers. The client now has the choice to continue with the variable rate or to take a higher fixed rate.

There are lenders, however, and these are the only kind we present to our clients, who are willing to promise in the loan engagement letter that upon conversion, the new fixed rate will be the best broker rate for that day. This is why it is very important to choose the right lender for your home loan.

How does one avoid varying payments?

Many people prefer not to have their mortgage payment change over time, since it makes budgeting difficult. There are solutions to this:

You can have your payment fixed, and it never changes even if the rate changes. The amount of your loan that is amortized will change to adjust for this.

You can bring your initial payments up to the higher level of a fixed rate loan and then any increases in the variable interest rate will be covered. This is the solution I recommend, since you will not be increasing the balance due on the mortgage.

How does a borrower know when his interest rate will change?

Due to the fact that the rate on your mortgage will vary with the base rate, it is important to keep an eye on the base rate. It is not very difficult to do this.

First of all, the base rate can only change 8 times per year (it's not that frequent), that is, when the Bank of Canada adjusts it directeur rate. When the bank changes the rate, this information is broadcast throughout the media: newspapers, radio and television).

Our clients receive an automatic notice, free of charge, via email, each time there is a change in the base rate. This way they know about any of these changes immediately when the Bank of Canada makes the change. We also provide predictions for coming months to better assist in decision making.

Variable rate with Ceiling option

Certain lenders can give a variable rate with a ceiling. That is to say, if the variable rate increases to more than the ceiling, your mortgage will be adjusted so that your rate will be equal to the ceiling. In other words, the ceiling rate is the highest rate for your mortgage.

Conclusion

The variable rate strategy should be carefully considered. It is a strategy that can save a homeowner thousands of dollars in interest rate costs. But it is important to keep these three things in mind:

1. Choose a variable loan with a good lender. There are a number of variations with variable rate loans.
2. Make sure you have a conversion option that will guarantee you the best fixed rate at conversion.
3. Keep track of interest rates or make sure that your mortgage broker stays in contact with you to advise you of changes.

Over the last fifty years, it has been shown that the variable rate mortgage strategy is the one that saves you the most money.