Need Help: Variable closed or Fixed mortgage?

[funky_monkey]

Three mortgage rates were offered to me and I have to make a quick decision to choose one. Any advice will be very appreciated!
Variable closed: Primer + 0.2% for 5 years term
Fixed: 3.4% for 3 years term
Fixed: 4% for 5 years term

[taylor192]

Its your decision, and you shouldn't make quick uneducated decisions.

Take the 5yr, 4%. I won't tell you why, that's what the search function is for.

[peter_ross]

Three mortgage rates were offered to me and I have to make a quick decision to choose one. Any advice will be very appreciated!
Variable closed: Primer + 0.2% for 5 years term
Fixed: 3.4% for 3 years term
Fixed: 4% for 5 years term

Bank of Canada says they won't change interest rate (affecting variable) until Q2 2010. So let's say by end of 2010, the interest rate increased 50 basis point (ie 2.75%). And let's _assume_ there's a steady increase 50 - 100 basis point every year for the next 4 years. In other words:

2009 2.25
2010 2.75 (up 50 bp)
2011 3.25 (up 50 bp)
2012 4.00 (up 75 bp)
2013 5.00 (up 100 bp)

On average of 5 year, you still have 3.45% over 5 year term. Plus your 0.2% spread, it's 3.65% -- not bad

Let's go nuts and assume the rate goes up crazily (inflation)

2009 2.25
2010 2.75 (up 50 bp)
2011 3.50 (up 75 bp)
2012 4.50 (up 100 bp)
2013 6.00 (up 150 bp)

On average, you still have 3.80% over 5 year term. Plus your 0.2% spread, it's 4.0% - same as your 5-year fix. Is this high inflation possible? Yes it's possible, but not likely.

I think the key is to enjoy the low prime rate in the first one or two years. I'd take the variable and keep the payment at 4%, so the amort period will be shorten, and you will own your home quickly.

[NuclearBlast]

Let's go nuts and assume the rate goes up crazily (inflation)

2009 2.25
2010 2.75 (up 50 bp)
2011 3.50 (up 75 bp)
2012 4.50 (up 100 bp)
2013 6.00 (up 150 bp)

On average, you still have 3.80% over 5 year term. Plus your 0.2% spread, it's 4.0% - same as your 5-year fix. Is this high inflation possible? Yes it's possible, but not likely.

I think the key is to enjoy the low prime rate in the first one or two years. I'd take the variable and keep the payment at 4%, so the amort period will be shorten, and you will own your home quickly.
The rate went down almost 2% in less than a year. So going up only 1.25% in two years (by 2011 in your example) is your idea of "crazy inflation"?

[someguy91]

If your cash flow can handle variable interest, take it. Otherwise, you're just paying the bank to take on your interest rate risk.

[i6s1]

the rate went down almost 2% in less than a year. So going up only 1.25% in two years (by 2011 in your example) is your idea of "crazy inflation"?

+1.

[peter_ross]

The rate went down almost 2% in less than a year. So going up only 1.25% in two years (by 2011 in your example) is your idea of "crazy inflation"?

No one has the crystal ball. I take that BoC will be very careful with raising rate in the next few years.

If the OP got 3.65% 5 year fix, I would be no doubt going for that. But 4%+ (although it's still very cheap money), I personally would go for variable. Again, it's a personal choice. No one can tell the future.

[taylor192]

No one has the crystal ball. I take that BoC will be very careful with raising rate in the next few years.
Lets hope not, or we'll end up with Japan's lost decade.

[wheel]

If your cash flow can handle variable interest, take it. Otherwise, you're just paying the bank to take on your interest rate risk.
+1 this is true.

BUT.

From what I've read, folks that take shorter term variable rate mortgages pay less money over the long term. They may however pay more in the short term.

So the question is, are you prepared and able to pay more over the short term? What if interest rates hit 18% and there you are? Do you lose your house if that happens? Is that OK with you if that happens? Are you prepared to take that risk - willingly or blindly?

For me, my family house is not an investment. It's where I live and raise my family. Paying a few extra bucks to guarantee that can't change is worth it to me, I always lock in for long term. I know for the term I can always meet the payment, and I further know that at the end of the term I have enough of the mortgage paid down so that even if mortgage rates are crazy high I can still meet the payment of high interest on a low balance - so I don't lose the house under any conditions. For this I am willing to pay a higher rate and lock in. But I've consciously made that decision.

Of course interest rates will never hit 18% (though I can remember when they did). Also mortgage rates will never go below 10% (I can remember thinking that,yet look at where we are today). And the stock market won't crash 40%. In other words, as noted above by another poster, you are taking on a real risk. There's a cost savings to doing so. Is the savings worth it to you to take on the risk? For me, no. For others, yes (or more likely they're just blind to the risk they're taking in many cases).

[bjserink]

Looking at Peter's second example of crazy inflation, you're still better off with the variable rate. Let's look more closely at how much interest you pay each year, based on a $100,000 loan amortized over 25 years (assuming the mortgage was started Jan 1, 2009):

Year Rate* Interest Balance
2009 2.45 $2417 $97064
2010 2.95 $2825 $94241
2011 3.70 $3442 $91592
2012 4.70 $4253 $89157
2013 6.20 $5468 $87022

*Rate adjusted to Peter's Prime guess plus the 0.2% modifier

Total interest: $18405

Now, with a constant rate of 4%, here's what you'd pay:
2009 4.00 $3957 $97623
2010 4.00 $3860 $95148
2011 4.00 $3759 $92574
2012 4.00 $3654 $89894
2013 4.00 $3545 $87105

Total interest: $18775

So, you would pay $370 more interest (about 2% more) over the 5 years with the fixed rate, even though the average interest rate is the same. This happens because in the variable scenario, the rate is low at the time when the balance is the highest, allowing more of the payment to go toward paying down the principle.

Personally, given your choices I would take the variable. However, I recently locked into a 5-year term because my choice was between a variable P+0.6% or a 5-year 3.5%. The only way the variable could be better in this case is if prime stayed below 3% for most of the 5 years.

[funky_monkey]

The only way the variable could be better in this case is if prime stayed below 3% for most of the 5 years.

It looks like prime rates would be impossible staying below 3% for most of the next 5 years according to historical prime rates.

http://i414.photobucket.com/albums/pp230/totofree/historical_prime_rates.jpg

[dcaron9999]

ouch ... prime reached 9.75% in March 1995 ... Looks like it has been in playing in the 5-6% range in the last 17 years or so ...

[i6s1]

ouch ... prime reached 9.75% in March 1995 ... Looks like it has been in playing in the 5-6% range in the last 17 years or so ...

Mostly, but I don't think that many people can afford rates to go back to that average. Most people prefer 5 year terms, especially when it looks like rates will increase. And I don't think that most people are budgeting for 5 year terms costing around 8%, and that's just the average.

Even looking at many of the threads here "I want to buy a house/condo" and people have no extra income to be able to afford overnight rates returning to 5-6%.