# Variable vs Fixed - First time home buyer



## joelones (Oct 9, 2011)

Variable vs Fixed - First time home buyer

Hello guys,

My wife and I are currently in the process of shopping for a home. As first time home buyers, this whole process is quite stressful and intimidating. Part of the fear stems from the fact that we're new to the real estate game, have no one to confide in and ultimately we're alone with no one to steer us in the right direction. I've spent quite some time reading and researching but now turn to the CMF for some advice.

We've met with one broker from BMO so far and I assume we'll get pre-approved soon. We carry no debt, have good credit and we're ready to put at least 20% down on a home. The BMO broker spoke to us about a 5 year fixed at 2.59%, I guess the discounted rate (or employee's rate, as he put it). I have doubts as to whether this is the most cost effective choice especially given the first 5 years of a mortgage. I do understand that the choice between fixed/variable is a risk-tolerance and expectations thing. Based on what my uneducated brain tells me -- weak economy, key rate just dropped, dollar's taken a dive and oil prices have tumbled -- I can't see rates increasing in the short term. But of course, I also don't know what I'm talking about.

In any case, I, on the other hand, would do this -- assuming this is possible. I'd opt for the the 3 year variable being paid at the 3 year fixed rate with fixed payments. 

Questions:

1) Is this possible to ask for? 
2) You are essentially overpaying and I assume the surplus falls under the prepay limit? What if the rate increases beyond the fixed? Are the fixed payments adjusted during?
3) I'm not entirely sure between open/closed and what to opt for?
4) Can the variable rate be swapped for the fixed rate at any time? I'm assuming then, the fixed rate will be the posted rate (which is higher) and not the discounted rate? Also, I'm assuming this is something you have to be on top of?
5) What is typically the fee for switching to a fixed rate? 
6) Is my logic sound?

And most importantly,
7) What are important things to remember, gotchas to look out for or anything else I'm missing with a variable mortgage? Or other questions I need to ask the broker? Also, I don't think the broker is going to work on getting the best rate, so I will need to shop around.

Thank you so much for any insight you guys can offer.


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## Homerhomer (Oct 18, 2010)

Instead of answering your questions, if you haven't seen it yet I suggest you sign up to this forum, and ask the same questions there, there are pages and pages of discussions dedicated solely to mortgages, and many participants there are independent mortgage brokers, who may (or may not) get you a better rate or option than just dealing with one bank.
http://forums.redflagdeals.com/official-mortgage-rates-thread-351105/1862/


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## CalgaryPotato (Mar 7, 2015)

What are they offering you for variable? That is really cheap for a fixed rate... I'm not sure I'd turn that down.


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## joelones (Oct 9, 2011)

CalgaryPotato said:


> What are they offering you for variable? That is really cheap for a fixed rate... I'm not sure I'd turn that down.


Not sure really, I neglected to ask as I was focused on the 5 year fixed. Now I'm unsure.


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## none (Jan 15, 2013)

Always variable. ALWAYS.

Take Variable and pay off at fixed rate. ALWAYS.


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## joelones (Oct 9, 2011)

none said:


> Always variable. ALWAYS.
> 
> Take Variable and pay off at fixed rate. ALWAYS.


What would you recommend for the term? 3 or 5 yrs? How would I know what's a good 3/5 yr variable rate before shopping around? ratespy shows rather high posted rates for the major banks.


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## none (Jan 15, 2013)

Whether 3 or 5 depends on your best guess as to how long you plan on owning your house.

If you plan on owning the house for 3 get 3, 5 get 5.

Use a mortgage broker - posted rates by major banks are designed to take advantage of the senile and ignorant. That's one reason people hate bankers. They do their best to prey on the ignorant and ill informed.


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## dougboswell (Oct 25, 2010)

joelones said:


> Variable vs Fixed - First time home buyer
> 
> Hello guys,
> 
> ...


First of all the "employee special" rate is not any special. Are you willing to pay BMO about .25% higher? Over 5 years that is a lot of money in interest you are donating to BMO's shareholders. If the BMO person says a lower rate cannot be found in the marketplace refer him to www.ratespy,com.

Very few lenders offer 3 year variables. 5 year variables can be as low as 1.99% (This may be a contracted rater that is higher with a cashback to give this effective rate). 

There are different forms of variables but most are those that when the Bank of Canada changes their rates the lenders do also. For example when the B of C raises the prime by .25% your mortgage rate will increase by .25%. When the Bank last lowered their rate by .25% lenders only dropped theirs by .15% . You can switch to a fixed during the term usually at no cost, However if you are on a 5 year term and want to switch at year 3 they will make you take a term of at least 2 years and you have no control over the rate they give you.

An open mortgage is one where you can pay off the balance at any time with no penalty. However you are going to pay a very high interest rate. This is good if someone knows they are coming into money in a couple of months. It is not good to take it for long term.

As this is your first mortgage make sure you ask questions such as can I port it if I have to move, what are the annual lump sum payments allowed and how much can I increase my payments by.

If you need to break your mortgage mid-term and refinance you need to know upfront how the penalty fee is calculated. With IRD's big banks tend to use the posted rate rather than the discounted rate to calculate. You could end up paying thousands od dollars more in fees by this method.

Research and research more before signing on the dotted line.


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## joelones (Oct 9, 2011)

Can someone please explain the differences pros/cons between going with one of the big banks or with a company like http://firsttorontomortgage.com. I was recently quoted really competitive rates for both variable/fixed.
Advisable?


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## MoreMiles (Apr 20, 2011)

joelones said:


> Can someone please explain the differences pros/cons between going with one of the big banks or with a company like http://firsttorontomortgage.com. I was recently quoted really competitive rates for both variable/fixed.
> Advisable?


Small banks
Good: better rate and more personal service
Bad: may bankrupt and sell your debt without your consent to another party, more prone to error, more unknown before closing.

There are people with mortgage money not coming down from small banks because someone messed up. No money = no changeover of ownership = no place to unload your moving truck on the closing day = more legal fee for lawyers to sort out ramifications = more stress

I would pay 0.1 to 0.2% more with a big-5 bank. It's not worth the stress.


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## Homerhomer (Oct 18, 2010)

MoreMiles said:


> Small banks
> Good: better rate and more personal service
> Bad: may bankrupt and sell your debt without your consent to another party, more prone to error, more unknown before closing.
> 
> ...


100% disagree, like the banks have never made a mistake ;-)


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## dougboswell (Oct 25, 2010)

MoreMiles said:


> Small banks
> Good: better rate and more personal service
> Bad: may bankrupt and sell your debt without your consent to another party, more prone to error, more unknown before closing.
> 
> ...


If a small bank were to go bankrupt some other lender would pick up the mortgage loan. Nothing would change for you except the name of the lender. I would not worry about facing lawyer fees etc - it won't happen. I would be more concerned about paying a higher rate to the bank and over the next 5 years having my hard earned money being handed out to the shareholders.


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## valuemortgage (Mar 4, 2015)

Not to mention that same of the big banks have terrible formulas to calculate penalties, and that 2 out of 3 major banks on the broker channel force collateral charges.

The average consumer has the perception that a bank means "something safe", while any institution that is not a bank with branches is "somewhat unsafe". A mortgage is a mortgage, same principles, same regulations. And keep in mind that some of the "non bank" lenders are owned (entirely or partially) by the banks themselves.


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## sags (May 15, 2010)

There was a thread a few years ago, about small US lenders suddenly leaving the Canadian market, sending homeowners scrambling around at renewal time.

If the home is worth more than the mortgage..........probably not a problem.

If a home is worth less than the mortgage.............good luck finding a new lender.

We don't even know how lenders would handle their own "underwater" clients.


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## joelones (Oct 9, 2011)

Another question, I just asked my BMO broker about the 5 year variable and he quoted me at 2.15%. We got pre-approved on the fixed at 2.59%, however, he mentioned that going variable would require using the bank of canada's higher rate and as such would need to recalculate the ratios...

Is this standard practice for variable mortgages?


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## dougboswell (Oct 25, 2010)

joelones said:


> Another question, I just asked my BMO broker about the 5 year variable and he quoted me at 2.15%. We got pre-approved on the fixed at 2.59%, however, he mentioned that going variable would require using the bank of canada's higher rate and as such would need to recalculate the ratios...
> 
> Is this standard practice for variable mortgages?


Yes. The Bank of Canada rate is used to calculate what your TDS and GDS ratios would be and if they fall under the guidelines. This assumes by the end of the 5th year the variable rate could have risen significantly and this sees if you could afford the higher payments. If your GDS and TDS fall within the guidelines you will pay only the 2.15%. A lot of people cannot qualify for a 5 year variable so they take a 5 year fixed at a lower rate because it does not change over the 5 years.


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## dougboswell (Oct 25, 2010)

sags said:


> There was a thread a few years ago, about small US lenders suddenly leaving the Canadian market, sending homeowners scrambling around at renewal time.
> 
> If the home is worth more than the mortgage..........probably not a problem.
> 
> ...


These were lenders that were lending to folks who were already carrying a lot of debt. When they could not renew with them they had trouble renewing with A lenders because of their credit issues or heavy debt loads. Some lenders would pick them up under their non-prime program but at a higher interest level. In today's mortgage world with stricter guidelines they would not have been approved in the first place.


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## joelones (Oct 9, 2011)

dougboswell said:


> Yes. The Bank of Canada rate is used to calculate what your TDS and GDS ratios would be and if they fall under the guidelines. This assumes by the end of the 5th year the variable rate could have risen significantly and this sees if you could afford the higher payments. If your GDS and TDS fall within the guidelines you will pay only the 2.15%. A lot of people cannot qualify for a 5 year variable so they take a 5 year fixed at a lower rate because it does not change over the 5 years.


Specifically what would be that rate? How would I go about looking that up?


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## Just a Guy (Mar 27, 2012)

none said:


> Always variable. ALWAYS.
> 
> Take Variable and pay off at fixed rate. ALWAYS.


This isn't really true...

Over the past 20 years or so it has been, which is why this is a common mistaken assumption. The reason it's been true is, for the last 20 years the prime rate has been falling or level.

It's the same kind of misconception as since housing prices have risen dramatically over the last 20 years, then they should continue to do so.

If rates start to increase, and eventually they will increase, then variable may not be the best scenario. 

Right now, there is no plan to raise interest rates, but I believe the desire is there...if it rises only a little, variable may still be better, but if it rises often, or dramatically, variable can be more expensive. It really depends on how good your crystal ball is as to how correct you are.

Right now, variable looks better.


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## none (Jan 15, 2013)

Just a Guy said:


> This isn't really true...
> 
> Over the past 20 years or so it has been, which is why this is a common mistaken assumption. The reason it's been true is, for the last 20 years the prime rate has been falling or level.
> 
> ...


Retrospectively you can pick and choose - much like stocks and mutual funds. Going forward you can't and therefore that's why you always choose variable. Fixed rates already have uncertainty incorporated into the price and therefore at worst they are an equivalent product. That's why you always choose variable.


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## joelones (Oct 9, 2011)

joelones said:


> Specifically what would be that rate? How would I go about looking that up?


Nevermind, found it on the BofC site, 4.74%.


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## joelones (Oct 9, 2011)

none said:


> Retrospectively you can pick and choose - much like stocks and mutual funds. Going forward you can't and therefore that's why you always choose variable. Fixed rates already have uncertainty incorporated into the price and therefore at worst they are an equivalent product. That's why you always choose variable.


If we do qualify for variable, I'd likely choose that route and pay the fixed rate as buffer.

I should be getting the pre-approve letter shortly, but I have yet to walk into other banks to see if they can beat 2.59/2.15%. I've had a number of non-banks reps contact me with 2.44/2.0% but I have some reservations about going that route.

Ideally, I'd like to walk into the banks and use those rates as leverage but I know the banks would in turn use the FUD tactic to steer me about from a non-bank lender. The game's afoot...


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## Just a Guy (Mar 27, 2012)

none said:


> Retrospectively you can pick and choose - much like stocks and mutual funds. Going forward you can't and therefore that's why you always choose variable. Fixed rates already have uncertainty incorporated into the price and therefore at worst they are an equivalent product. That's why you always choose variable.


I think the banks have proved, on many occasions, that their crystal balls are no better than anyone else's.

Let's look at the numbers provided "2.59/2.15%". If the feds decide to raise the rate .25%/year over the life of the mortgage, variable will be worse, plain and simple, not equivalent at all, just simple math.

Could the feds decide to do this? Who knows, I doubt the banks know any better...who could have predicted the oil crash? I think the oil crash is one of the reasons the rate went down instead of up like the Feds had been hinting at for the past few years...


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## nobleea (Oct 11, 2013)

Just a Guy said:


> Let's look at the numbers provided "2.59/2.15%". If the feds decide to raise the rate .25%/year over the life of the mortgage, variable will be worse, plain and simple, not equivalent at all, just simple math.


It's not that plain and simple. If the variable rate increases by 0.25% annually on the anniversary of the mortgage, the difference is about $250 on a $250K mortgage (fixed being cheaper by 0.3%). That's not a huge spread.

Summary for fixed period Variable interest rate loan Fixed interest rate loan
Average interest rate: 2.65% 2.59%
Total repayments: $68,182.86 $67,974.41
Total interest payments: $30,473.60 $30,010.79
Total of principal payments: $37,709.26 $37,963.62
Balance at end of period: $212,290.74 $212,036.38 

If it's less than 0.25/yr or the rate is held flat, or even goes down one year, then you're ahead with variable.


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## joelones (Oct 9, 2011)

You a guys are really make this hard on me to decide between variable/fixed...lol

Just an ignorant question about the math you refer to. Assuming the rates are where they are and assume a .25%/year over two years. Wouldn't that signal the borrowers to switch to fixed at that point? The owness is on them to watch the rates, judge the economic climate, and not sit idlely by. More so, asssuming the rates don't jump by much or the rate change happens somewhere in the middle of the term, you may still be on top. Also, the break penalty is lower with variable.


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## nobleea (Oct 11, 2013)

By the time it is time to switch to variable, you're better off staying with variable as the fixed rate that you'd be switching to would be higher. (if that made sense).

With 0.5% increase over 2 years, your variable rate would be 2.65%. But the fixed rate that you'd be getting at that time would not be 2.59, it would be well in to the 3's. While fixed and variable don't move in lock step, there is certainly a correlation.


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## Just a Guy (Mar 27, 2012)

Joellens,

I wasn't meant to make it difficult, as nobleea pointed out the difference won't be a lot. I was just pointing out the faulty logic that variable is *always* better. 

Personally, I believe you really can't go wrong and shouldn't worry if the rate is below 5%. There is no point in worrying about a few hundred dollars when you are dealing in the hundreds of thousands...it's just not worth the time and stress.


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## none (Jan 15, 2013)

Just a Guy said:


> I think the banks have proved, on many occasions, that their crystal balls are no better than anyone else's.



And that's the point. It's unknowable and therefore you shouldn't worry about it. As I said previously, Banks have VERY smart people working out rates and therefore, because variable and fixed are at worst equivalent products you might as well go variable which ensures you save money immediately rather than you basing it on a hunch which has no basis in reality (see previous sentence).

Putting all your money in one stock is a bad idea. However, you can find examples of when it was a genius thing to do. That doesn't mean you should do it. The answer about fixed versus variable is ALWAYS go variable. 

Basically going fixed is equivalent to going variable and buying insurance. Generally if you don't have extreme reasons to buy insurance you shouldn't.


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## none (Jan 15, 2013)

joelones said:


> You a guys are really make this hard on me to decide between variable/fixed...lol
> 
> Just an ignorant question about the math you refer to. Assuming the rates are where they are and assume a .25%/year over two years. Wouldn't that signal the borrowers to switch to fixed at that point? The owness is on them to watch the rates, judge the economic climate, and not sit idlely by. More so, asssuming the rates don't jump by much or the rate change happens somewhere in the middle of the term, you may still be on top. Also, the break penalty is lower with variable.


Don't worry about it. You figured it out before. Take variable and pay it off as if you took fixed.

it's simple to set up a simulation in excel to evaluate the buffer this provides. It's quite remarkable.


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## joelones (Oct 9, 2011)

none said:


> Don't worry about it. You figured it out before. Take variable and pay it off as if you took fixed.
> 
> it's simple to set up a simulation in excel to evaluate the buffer this provides. It's quite remarkable.


Thanks. I'd be very interested to understand how much buffer this strategy would provide. Would you be able to direct me to said spreadsheet or explain how to make one? Again, it's much appreciated.


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## birdman (Feb 12, 2013)

Didn't read the entire thread but one option that is available depending on the lender is to spread your risk over different terms. For example, take 33% in variable, 33% in say 3 yr, and 33% in 5 yr. Just a bit of a twist and that is what my son and his wife have done. Regardless, don't stress over it and in todays rate environment I don't think you can go too wrong in any term. One other thing to remember is that rates are at their low point and I would think their is more of a good chance for them to go up as opposed to down but nobody knows when and you cannot predict rates with certainty.


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## joelones (Oct 9, 2011)

joelones said:


> Would you be able to direct me to said spreadsheet or explain how to make one? Again, it's much appreciated.


Nevermind, I should be smart enough to one together myself. All those dollars parents invested in my education should count for something...lol


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## none (Jan 15, 2013)

Here you go. Too late, I likely have more education than you anyway 

https://www.dropbox.com/s/e5l2is1zcrutkqh/mortgage_optimize.xls?dl=0

I haven't looked at it for a few years though - I'm convinced that waiting the market out another 3-4 years and investing is likely a better route for me.

Hopefully it's not too buggy.


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## joelones (Oct 9, 2011)

none said:


> Too late, I likely have more education than you anyway .


Not sure buddy, you're speaking to someone with a high school equivalency diploma...

In all seriousness, appreciate the file, will take a look at it.



none said:


> I haven't looked at it for a few years though - I'm convinced that waiting the market out another 3-4 years and investing is likely a better route for me.


I'd probably like to wait it out too, in fact I'm not sure whether it's the right time, however, I've been saying the same for the last ten years and look where it got me. Such a stressful decision either way.


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## none (Jan 15, 2013)

If you have been investing properly then you're probably still farther ahead than if you bought a house. no worries, if you don't suffer from the child-like need to rent a house from a bank then renting is pretty awesome in most respects. I prefer it actually. Possessions end up owning you.


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## amitdi (May 31, 2012)

Just a Guy said:


> This isn't really true...
> 
> Over the past 20 years or so it has been, which is why this is a common mistaken assumption. The reason it's been true is, for the last 20 years the prime rate has been falling or level.
> 
> ...


I do not agree with your analysis. True that we have data for only a falling rate scenario. So we can only make theoretical analysis on the reverse scenario. But I think variable will win over fixed even in a rising rate scenario and here is why I think so.

Variable vs fixed is basically who is the risk taker - consumer or the lender. When you take fixed, the banks essentially take the risk and they make you pay for the risk by charging you higher. Variable right now is 2.1 (P-0.75% say) and fixed is 2.6%, essentially 0.5% higher at a point in time. When the rules reverse, there will be a brief time when fixed will win, but when we settle back in an equilibrium, the lenders will just make the premium larger. So at P=6%, we will have variable at 6%(P+0) and fixed at 7.25%, thereby charging a much higher premium for the added expectation that the rate is rising.

Saying that fixed will win is like saying that the house will win against the gamblers. You may have a winner once in a while but in the long run, variable is expected to win the way the game is played.


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## Jagt Mirage (Sep 29, 2014)

hmm.. a 50 basis point spread between fixed and variable is a bit of a wash IMHO, perhaps a bit more skewed towards the former. However, an important factor I think is how much are you willing to pay each period? are you paying minimum payments? or are you doing accelerated like double payments. The latter favors variable as conceptually you're trading for lower rates today, in exchange for the possibility of higher rates in the future. If you can take advantage of the period when it is lower, and you accelerate your payment to pay off more principle, then by the time the rates finally do rise to the same level as fixed or above, you would've paid off more principle so that it offsets the higher rates.


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## MoneyGal (Apr 24, 2009)

amitdi said:


> I do not agree with your analysis. *True that we have data for only a falling rate scenario*.


The Milevsky research through IFID is from 1950 onwards. 

http://www.theglobeandmail.com/glob...ble-rate-mortgage-always-best/article4330257/

http://www.ifid.ca/pdf_workingpapers/WP2001A.pdf


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## crazyjackcsa (Aug 8, 2010)

I love that in both 2010 and 2012 the advice was "Mortgage rates will rise! Lock in now!" I listened to the talking heads in 2007 and went fixed. That move cost me thousands of dollars. When it renewed I ignored the pundits and have begun to recoup that overcharge.

Calculate the fixed payment, go variable and make the fixed payment on it. Get a mortgage with prepayment options. If things start to shift, start making some prepayments.

It's not new advice, it isn't sexy and it isn't rocket science, but it's the best way to go.


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