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Fixed vs Variable


So many clients are working on the age old debate of whether to go variable or fixed.  As with most options, there are positives and negatives.  This is precisely what makes the decision so frustrating.  Add in the fact that we’re dealing with hundreds of thousands of dollars and we’ve got a pretty big choice to make.  I am going to take you through two comparisons that will hopefully make your decision a little bit easier.  I will run the analysis based on what history has told us.  History is quite a clean cookie and has managed to tell me the truth over the years.  The other analysis will be the brass taxed numbers.  It will be based on running relevant current numbers and analyze what will be for the future.  Since we do not know what the exactly future will bring, some assumptions will be made.

Fixed mortgages offer piece of mind.  Once you select your term, you can sit back and not think about the bugger until your term runs out.  You know what your payments are and do not have to worry about what the bank of Canada does with fluctuating rates, inflation, and blah blah blah.  The downside of a fixed mortgage is the fact that you could be taking advantage of how low prime is by paying down a whole bunch of your principal.

The variable mortgage has been a real sweet deal for the past years.  As far as a historical principle is concerned, about 77% of borrowers in variable mortgages will save over their 5 year fixed counterpart.  The history of the fixed versus variable analysis is reflected in the attached chart entitled “the history – fixed versus variable.”  The blue line represents the 5 year fixed mortgages.  The white line is the moving average of the variable mortgage.  The variable white line beats the 5 year fixed 77% of the time.   Although about 23% of the time, the 5 year fixed claimed a few victory dances of his own.  So as far history is concerned, the variable mortgage has better odds to save money over a 5 year term.  Check out where prime was during the approximate year of 1982.  Yeesh, this is why most parents think variable mortgages are like a dirty swear word.  My dad smacked me on the mouth when I suggested a variable for my sister.

The next comparison is running actual numbers of a fixed versus variable mortgage with speculation of what prime will be over a 5 year term.  I will run some numbers of a 5 year fixed mortgage and then run a variable mortgage with the same payments in order to set a control.  We will then work in various increases of prime over the 5 year term.  This will give us an idea of the actual savings going variable versus fixed.  But first, a few assumptions:

–          I am using a 5 year fixed rate of 3.89%.  This is for a 30 days quick close rate, with a few stipulations.  It is a good rate but we might even be able to do better or not as good; I’m just not interested in writing cheques that my butt can’t cash.

–          I am using a variable discount of Prime -.60%.  The discounts are decreasing and a good variable might drop to Prime -.70% but I just like being conservative because that’s what I’m into these days.  Being conservative is like polka dots for the fall season.

–          I am using a mortgage amount of 300K.

–          There are no CMHC or Genworth premiums.

Now please refer to the attached spreadsheets entitled fixed versus variable attachments  As you will be able to see, I ran a few scenarios of what prime will increase to over a 5 year term.  If you think prime will steadily increase to 6% over the next 5 years, you are better off with a variable.  You will save about $6100 over your term.  From the second page, we set prime to increase to 6.50%.  In this scenario, you are still better off going variable as you are saving about $2400.The third page runs numbers if prime increases to 6.75%.  This is the sweet spot; whatever that means.  This is where savings are quite minimal for choosing variable over fixed.  You are still saving $660 but over the full 5 year term.  And if we go up to 7%, you are better off going fixed.  The tricky part lies in the fact that no one knows where prime will be in 5 years; not even the finance minister himself.  I’ll bet he wishes that he had a crystal ball along with a rabbit’s foot for good measure.  Those rabbit foot key chains were weird.  Man, I just dated myself.