The variable mortgage strategy – Hypotheque
The variable mortgage strategy – Hypotheque
by Gregory van Duyse
Variable Rate Home Loan Strategy
Many borrowers know and understand and consequently use, variable rate mortgages today than ever before.
Between the years 1950 and 2000, a variable rate mortgage was the most economic mortgage strategy in 88% of the cases, according to a study reported by Dr. Milevski of York University of Toronto.
It is clear that this strategy, merely by its variable nature, infers a risk, but over the last years, excellent results have been achieved by assuming this risk.
Description
The interest rate of a variable rate home loan changes with the base rate of the large Canadian banks. The lending institution does not give you a fixed rate, but rather a rabais on the base rate. This is why variable rates are expressed as a base rate less a percentage.
For example, if a bank quotes a variable rate mortgage as base minus .9%, this means that if the base rate is 6%, the loan rate will be 5.10%, or 6%-.9%. This will remain applicable for the period that that base rate is in force. The Bank of Canada meets 8 times a year to consider whether to change the rate, and therefore it can change as many as 8 times, but it does not have to if they decide to keep the rate the same. If the Bank of Canada lowered the base rate to 5.25%, the rate on that same loan would become 4.35% during the next period.
Advantages
- The variable ratestrategy has been the best choice over the past years, especially in the periods of falling or unchanging interest rates. – It permits one to take advantage of falling rates during the period of the mortgage. – Mortgage payments are usually lower in the case of variable rate mortgages. – This option is offered by a lot of lenders. – It exists with many lenders.
Disadvantages
-The rates are variable, so they can go either up or down, adding a risk factor. – Mortgage payments may change up to 8 times per year, although you can avoid varying rates -see below. – You have to note when the Bank of Canada is changing its base rate, so you can decide what to do with your home loan.
When is it good to use this strategy on the long term?
The variable rate strategy has been the best choice over time, as studies have shown. This has been the case in decreasing or stable interest rate environments, but it is important to keep track of interest rate 8 times a year to manage this strategy effectively.
You can change to a fixed rate option when you have a variable rate loan, but you have to be careful about the new fixed rate. Some lenders (your mortgage broker should be familiar with which ones) increase the fixed rate when the conversion option is being chosen.
Here is the reason. If a client wants to convert, it is because the rates have gone up. The bank gives him the option of converting, but the rate he will receive on the day he converts is not mentioned 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 have a higher fixed rate.
Certain lenders (all of the ones we recommend to our clients) promise in the loan engagement letter that when the client makes the choice to convert, he will receive the best broker rate for the loan for that day. You have to be careful in choosing your lender if you are going to use the variable rate strategy.
How does one avoid varying payments?
The idea that the mortgage payments can increase or decrease with a variable rate mortgage makes many people uncomfortable. There are two solutions:
You can opt to have a fixed payment, regardless of changes in the rate. What will happen is that the amortization amount will change instead.
You can raise your payments from the beginning so that they are equal to the mortgage payment you would have on a fixed rate mortgage, which is normally higher. In this way, if the rate increases or decreases, your payments will probably remain the same. I prefer this solution.
How to stay current on changes on the mortgage interest rate
Since your rate will be changing with the base rate of the Bank of Canada, you have to know each time it changes. This is not difficult.
This base rate can change only 8 times per year, so it is not as if you have to keep track each day. It only happens when the Bank of Canada changes its directeur rate. This is an important news item that is reported in the newspapers, on the radio and on T.V. and on internet news.
In addition, we offer to our clients (free of charge) an email subscription service that allows them to follow the change in the base rate each time the Bank of Canada meets. In this way, our clients know the change in the interest rate the same day it occurs, and they also receive predictions for the coming months
Option: Variable rate with a ceiling
It is possible to obtain a mortgage with a variable rate that has a cap on the rate. With this type of mortgage, if the rate keeps increasing, once the cap rate is hit, it cannot increase any more. The ceiling rate or cap rate on the loan becomes the highest rate your loan can go to.
Conclusion
The variable rate strategy is an option that one should examine closely. Many thousands of dollars of savings can result from this choice. But here are three pieces of advice:
1. Choose a variable loan with a good lender. There are a number of variations with variable rate loans. 2. Make sure you obtain 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 touch 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.
Gregory is an Accredited Mortgage Professional (AMP). To get more information on mortgage rates – taux hypothèque, please visit: Mortgages – hypothèques
Tags: variable mortgage strategy, Hypotheque
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