Variable & Adjustable Rate Mortgages – the best mortgage programs available:

Like most home owners, you want the certainty of a fixed rate mortgage, right?  Yes, 5-year fixed rate mortgages are the most poplar mortgages around.  And when mortgage rates are moving up, you may have heard from a lot of media pundits that it is time to fix your mortgage rates for the longest term you can afford.  Well, they may be all wrong.  I will certainly understand if you and your family feel more secured with a fixed rate mortgage.  It is only human nature.  But: how high a premium will you end up paying for this degree of certainty, or security, over the term of your mortgage?  I think, generally speaking, it may be costing you too much.

When you arrange a mortgage through me, I can demonstrate to you, with a simple computer spreadsheet, how much money you will likely save over the term of your mortgage with some simple assumptions.  One of those assumptions is how high you think prime rate will go in the same time span.  We can play with this and see what the resulting differences are.  But that can come later.

What I would refer to you to now are two very well written papers by Prof. Moshe A. Milevsky, Ph.D., of York University, Toronto.  The time you find to read them through will be time well spent.

The first one is a research report dated March 25, 2001.  It is called: “Mortgage Financing: Floating Your Way to Prosperity” (click HERE).  In this report, Prof. Milevsky provides detailed evidence that Canadian consumers are better off, on average, financing a mortgage with a short-term floating (prime) interest rate, compared to a long-term fixed rate.  The contribution of this report is to rigorously quantify the benefit of the floating strategy by introducing and developing the concept of the Maturity Value of Savings (MVS) and the Total Months Saved (TMS).  More specifically, he shows that during the period 1950 to 2000, Canadians would have saved approximately $22,000 in interest payments — on a $100,000 mortgage amortized over 15 years — by borrowing at prime versus the five year rate.  During the period 1950-2000, he estimates that a consumer with a $100,000 mortgage — that was to be repaid over the course of 15 years — would have spent an average of $22,000 more in financing costs by borrowing and then renewing at the 5-year rate, compared to borrowing at prime and renewing annually.  He concludes that history is unanimous in its verdict and the odds favour floating rate interest payments as a cheaper alternative to long-term fixed rate financing.

The second paper is a more recent one, dated April 15, 2004.  It is called “Mortgage Financing: Should You Still Float?” (click HERE). Needless to say, he has concluded that the answer is an unequivocal “yes”.  His thesis is based on risk management principles, not crystal ball projections.

I have to admit these papers are written by an academic and a bit dry to read.  What I am trying to convey to you is that, on average, you will always come out ahead with floating rate or variable rate mortgages, based on bank prime, over the life of your mortgage.  It does not matter how volatile prime rate may get.  It is not an opinion.  It is a demonstrable fact.  And it has been backed up by academic studies.  It is even more so when the spread between the short floating rates and the fixed longer term rates are increasing.

Because you deserve the best advice from me, it will be unprofessional for me not to share this piece of important information with you.  The fact may be contrary to what a lot of so-called experts say.  Financially, it matters not a bit to me whether you choose variable or fixed rate mortgages.  I am compensated more or less the same either way.

If it is the comfort of a fixed monthly payment that you want, I can always arrange that for you even with a variable rate mortgage.  When you make higher monthly payments that you can afford, you build up equity and pay off your mortgage that much sooner.  By the way, you can always fix the rate at a later date, if you become concerned with prime rate going too high.  But that’s really not the right time to lock in, is it?  Just remember, prime rate never stays high for long.  It is a risk worth taking when you have sufficient equity in your home.  Equity that you build up quickly with the much lower variable rates.

NB: For fixed rate mortgages, the contract rate is fixed for the term.  In variable or adjustable rate mortgages, the rate will vary according to, usually, the Canadian Bank Prime Rate (but not always).  For example, the rate can be expresses as Prime minus 0.80%.  This contract rate will remain the same during the term, usually 3 or 5 years.  Some lenders will vary the rate as soon as the Prime rate changes – hence a variable rate.  Others may change after the next scheduled payment or on the 1st day of the month following – hence adjustable.  You must read your contract carefully.

PS: You may wish to get the latest Adobe Reader to read the papers.  Click here and follow the instructions.

Below is another excellent video from The Mortgage Teacher: