What is the best option between the fixed mortgage rate and the variable mortgage rate? The answer is not scientific when making the choice, because we cannot predict with certainty whether interest rates will go up or down. Your decision is based on your approach to risk and the flexibility of your budget. Let’s first see what’s different.
Fixed Rate Mortgage
A fixed rate means that the interest rate stays the same throughout the term. This allows you to have the same monthly payment at the same interest rate over a short or long period ranging from 6 months to 30-year fixed rate. This rate is suggested for risk-averse individuals who want to approach their mortgage with caution, based on a fixed budget and over a specified period. If you prefer to keep your payments constant and keep the same interest rate to avoid any change in your budget, it would be best to opt for the fixed rate. Check 30-year fixed rate well explained here.
Flexible Rate Mortgage
he variable rate for its part fluctuates according to the policy interest rate of your country , according to the discount rate of the Bank of Canada, the Euribor for the countries of the European Union, the rate of the Federal Reserve to United States, Libor for Great Britain, etc. These rates reflect market conditions. The variable interest rate of your mortgage is composed of the key rate and a margin added by the bank. For example, a floating rate could be the key rate + 1%, and the term is renewed annually.
A homeowner who chooses the variable rate obviously hopes for an immediate rate cut to take advantage of a lower mortgage rate, while those who have a fixed rate will keep the same rate. But this principle works in both directions because the mortgage rate can also rise following a rise in the rate of the Central Bank. This is a rate for people who are not afraid of risk and who have some flexibility in their budget.
Variable rate derivatives
However, banks often offer the option of setting monthly payments with a variable rate. In this case, if the rate fluctuates, it is the proportion of the interest and principal payment that fluctuates within the monthly payments, and the amortization changes accordingly. The sum total of the interest payments increases or decreases according to the fluctuations of the key rate, but not the monthly payment.
There is also an option to go for a variable rate with ceiling for a premium at the bank. In this way, the borrower pays to secure himself from a rate hike that could not afford setting a limit on his own interest rate. The mortgage rate can always increase but will never exceed the ceiling. It is a variable rate option that could satisfy a borrower normally attracted to the fixed rate.
Fixed rate vs. variable rate in the past
No one can predict with certainty the future fluctuations in the key rate, although many are putting a lot of effort and energy into doing so. If we take the example of past years, those who chose a variable rate in the 1980s obviously lost when the rate began to climb unprecedented, and those who chose a fixed rate just before the credit crisis of the 1980s. 2007 have never been able to take advantage of the lowest rate ever recorded. These are examples where the fluctuation of interest rates was not predictable.
However, one can conclude on a generality. Historically, those who have opted for a variable rate have won most of the time. Research by Dr. Moshe Mile sky of York University has shown that from 1950 to 2007, it was preferable about 90% of the time to choose a variable rate. Subsequently, during the credit crisis where the key rate has never been so low, it is hard to believe that blocking the rate with a fixed rate would be a mistake.
Which mortgage loan to choose?
The profile and budget of the borrower determines the type of rate he must adopt. The starting choice is not irreversible, but changing the rate implies a penalty. Same thing if you opted for a closed loan instead of an open loan. We must be careful not to rush a change following a pronounced fluctuation of the policy rate, because often the penalty proves higher than the possible economy by changing rates. But if at the beginning of the mortgage you have to make a decision about the rate, the past has shown that it was better to opt for a variable rate, if the budget allows.