Can a variable rate save you money in 2008?

Posted April 2008

At True North Mortgage, we spend our days watching mortgage interest rates going up and down at various Canadian lenders.

We've noticed over the last few months that 5-year fixed rates have been trending downward, which was predicted by big banks, such as TD, RBC and CIBC. In fact, most major lenders have issued statements suggesting that the 5-year fixed rates will be trending lower all year, and may dip below 5% by the end of the year, depending on how rough the recession is in the U.S. (rougher means lower 5-year rates).

The Canadian government has already responded to the weakness in the U.S. by lowering the prime rate. In fact, on Tuesday, the Bank of Canada will likely lower prime rates by another 0.5%, bringing a True North Mortgage variable rate product to 4.0% (P-75%).

With the lower variable rate now offered, a client asked if it would be prudent to break their fixed-rate mortgage to take a variable-rate one, and then lock in at a future date when 5-year fixed rates are even lower.

After running the numbers, we were surprised by the results. Normally, we're cautious about breaking a mortgage term, as the penalty can be quite stiff.

In their case, their current mortgage balance was $265,000, locked into a fixed rate of 5.74%. They were paying $1,655 per month and have been for about 1 year. At the new variable rate of 4.0%, the payment would be reduced to $1,394, for a savings of $261 per month. Plus, thanks to the magic of amortization schedules, the amount put down on principal would be increased by $114 each payment, adding up to even more interest savings later on.

In total, the client would be better off by $375 per month for switching to a variable-rate term. The client would have to pay a prepayment penalty of $3803, which would only take 10 months to cover off. So with a 120% rate of return, the switch to a variable rate in this case is a good decision. The only down side might be if the client chose to lock-in their rate within the next 10 month period at a higher 5-year rate than they are currently paying. But considering that factors are pointing to a downward trend in 5-year fixed rates, they can remain cautiously optimistic that they'll continue to enjoy their variable rate switch.

Are you currently in a 5-year fixed rate term of more than 5.50%? Please give us a call or stop by one of our convenient store locations. Our expert mortgage brokers will take a look at your situation, quickly outline your details and work out your best option. It's free and no obligation!

Learn more about variable vs fixed rate mortgages.