You can save money with a Variable rate

Linda Wickstrom – Mortgage Broker

In this month’s column I want to clarify the difference between a variable rate and a fixed rate, and explain how a variable rate can work for you. Before I go into that I also want to share some exciting news that will make home buying easier here in the lower mainland for sure and in other parts of Canada.

CMHC and GE have announced they are taking the ceiling off the five per cent down payment purchase, here in the lower mainland you were not able to purchase over $300,000.00 unless you had 10 per cent down.  CMHC and GE have lifted that ceiling so now as long as you can qualify income wise, you can go into any purchase and put five per cent down.

Now on to the meat of the column. Everybody has heard of Variable Rate Mortgages (VRM) – but very few people understand what they are, how they work and so people tend to shy away from one of the best products available to help them pay down their mortgage faster. The greatest difference between VRMs and fixed rate mortgages is how the rates are set. VRM rates are set based on the Bank of Canada rate. The chartered banks add a slight premium to the Bank Rate to establish Prime Rate. This is what most lenders use to price their various VRM products. In our system the Bank of Canada uses its bank rate to control inflation in the economy. When little or no inflation is present as is the case right now, this rate tends to be set at very low levels and is relatively stable.

The fixed rates, on the other hand are set based on the yield in the bond market. The bond yields are very volatile and tend to fluctuate, often due to political and economic conditions. This volatility makes it impossible to gauge what fixed rates will do, even in the short term.

Here’s how the smart consumer wins by taking a VRM over a fixed rate product. Right now you can get a discounted VRM rate, around 3.90 per cent. Conversely the discounted rate for a five-year mortgage is around 6.0 per cent. The smart consumer takes the VRM with the low rate but makes the payments as if the mortgage is at the higher fixed rate. The difference between the minimum required payment, (calculated at 3.90 per cent) and the payment actually being made (calculated at six per cent) is additional monies that are going directly to the principal. Even if the Prime rate starts to increase, it will probably take a long time before it reaches a level close to the fixed rate currently available.

The VRM also has the option to lock in at any time to a fixed rate. But don’t be too hasty in doing just that. A quick analysis shows, that if you took out a five year VRM anytime between January 1990 and now, set your payments at the higher rate, your outstanding mortgage balance would be lower than if you took a five year, fixed rate mortgage.

Hope you have enjoyed this months tidbits, and please go to my website (www.mortgagemaster.ca) and explore there is even a mortgage calculator, you can test the waters and see what you qualify for. See you next issue!