# without hindsight, isn't variable rate always preferrable to fixed rate?



## joncnca (Jul 12, 2009)

i haven't done any calculations, i'm thinking psychology. and of course, hindsight is always crystal clear, but let's assume that we're looking forward in the case of a person who is shopping around for a mortgage at the present day.

there are probably armies of highly paid financial analysts working for the banks, who are using every predictive and statistical tool in existence, to try and predict where mortgage rates are going. and in principle, i would think that the main reason a bank would offer a fixed rate mortgage is because they believe that they will make money on it. if they're offering you 4%, they have probably predicted that interest rates will be at 3% so they can make that 1% off of the homeowner. it just wouldn't make sense if they offered 4% and expected prime rates to soar, because they'd loose money. 

the banks work for themselves, and their shareholders, and very insidiously project an image that they are trying to help the homeowner. certainly, they can't totally bite the hand that feeds them, but i think they are trying to milk the homeowners as much as possible without actually sucking them too dry to maintain their obligations (to the bank).

so all this being said, i would argue that the variable rate is almost always a better deal than the fixed rate, because they're banking on your anxiety over the unpredictability of a variable rate mortgage. they're scaring you into taking the fixed rate mortgage, because all of their predictions tell them that they will actually make more money off of you if you take the fixed rate mortgage (i.e. rates won't increase as much as they would have you believe).

more evidence to suggest this truth, is the fact that many banks will offer to let you lock in a mortgage rate at the current fixed rate. they are totally trying to exploit your anxiety over rising interest rates, even though they have probably predicted that the interest rates will not increase as much as they would have you believe.

am i jaded here? is there any logic in what i'm saying?

assumption disclaimer: for arguments sake, let's compare a 5 year prime -0.85% variable rate mortgage vs. a 3 year 3.5% fixed rate, both closed. very disparate variable/fixed rates may affect what i'm saying here...


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## andrewf (Mar 1, 2010)

The short answer is yes, you nearly always pay more with a fixed rate. That is because part of the cost of that mortgage is 'interest rate insurance'. You off-load interest rate risk for a five year term onto the lender.

So, it depends on your risk tolerance. If you can tolerate the risk, go with variable. And if you can't tolerate the risk, maybe ask yourself whether you should move to a less expensive property, as you must be pushing the boundaries of affordability.


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## Andrej (Feb 25, 2010)

What do you think about 3.79 variable or a 10 year 4.99 fixed?


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## joncnca (Jul 12, 2009)

andrewf said:


> The short answer is yes, you nearly always pay more with a fixed rate. That is because part of the cost of that mortgage is 'interest rate insurance'. You off-load interest rate risk for a five year term onto the lender.
> 
> So, it depends on your risk tolerance. If you can tolerate the risk, go with variable. And if you can't tolerate the risk, maybe ask yourself whether you should move to a less expensive property, as you must be pushing the boundaries of affordability.


i agree with the essence of this statement that really, one should strive to be in a position where they can tolerate the risk (of a variable rate mortgage), and if they can't, then they should probably move to a less expensive property. to take it one step further, even if they could afford to pay the higher amount with a fixed rate, i don't see why they should, because it's just like giving money away to the bank for no reason. well, the reason is to appease their anxiety over fluctuations in the interest rate, but it's baseless when it comes to dollars and cents, because if the homeowner could actually stand to gain a monetary benefit from going with a fixed rate, the banks probably wouldn't even offer it.

i think the goals of the homeowner are fundamentally at odds with those of the bank/mortgager.

and regarding:
What do you think about 3.79 variable or a 10 year 4.99 fixed? 

variable would still be preferable, because it implies that prime could also decrease, in which case you pay even less interest. and saving more in the present is better, cause you'd have to discount future potential savings to the present otherwise.


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## kubatron (Jan 17, 2011)

Andrej said:


> What do you think about 3.79 variable or a 10 year 4.99 fixed?


Huh?

variable is 2.15-2.25 now.


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## Plugging Along (Jan 3, 2011)

If it's an open variable, then it was about prime +.7 or .8


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## andrewf (Mar 1, 2010)

Comparing an open variable to a closed fixed is apple to oranges.


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## Potato (Apr 3, 2009)

joncnca said:


> there are probably armies of highly paid financial analysts working for the banks, who are using every predictive and statistical tool in existence, to try and predict where mortgage rates are going. and in principle, i would think that the main reason a bank would offer a fixed rate mortgage is because they believe that they will make money on it. if they're offering you 4%, they have probably predicted that interest rates will be at 3% so they can make that 1% off of the homeowner. it just wouldn't make sense if they offered 4% and expected prime rates to soar, because they'd loose money.



It's not quite like that: the army of financial analysts are the bond traders, so it's a step removed. The banks don't lend out a fixed mortgage and then take on the interest rate risk themselves with floating financing, they generally "duration match" their own borrowing to their mortgage lending. So if you want a variable-rate mortgage, they source that from floating-rate funding; if you want a 5-year fixed mortgage, they don't calculate a rate to charge and then borrow floating, they just charge a spread and borrow with a 5-year loan themselves.

But the "rate insurance" still comes in from the bond market...


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## nathan79 (Feb 21, 2011)

I would say so. I am basing this on hindsight, but at the time I locked in back in 2007, the variable rate was actually higher than the fixed rate, near 6%, and the 5 year fixed rate was much lower at 4.85%. In retrospect, it was obvious the banks knew that rates would drop in the long term. They could pretend they were giving me a good deal, when in reality it would have made more sense to go for the 6% rate.

Today, the banks will charge you 3.75%, or whatever, for a five year term, becuase they know that rates will stay low for the foreseeable futher, and you will be a few years into your term by the time rates approach that level.


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## balexis (Apr 4, 2009)

Potato: Interesting post! So, how does the rates from the Bank of Canada influence the bond market/mortage rates?


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## larry81 (Nov 22, 2010)

anyone shopping for a mortgage should look at ingdirect offer


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## Financial Cents (Jul 22, 2010)

I'm totally kicking myself right now. We closed on our house in December 2010 and got a 5-year fixed rate for the "insurance". Well, rates still haven't gone anywhere despite "expert" promises they would. 

In hindsight, I've learned my lesson: I will never go with a fixed-rate mortgage again. I'll go variable.

The "experts" don't know any better than anyone else what the future might hold.


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## Potato (Apr 3, 2009)

balexis said:


> Potato: Interesting post! So, how does the rates from the Bank of Canada influence the bond market/mortage rates?


I don't know enough about the bond market to give an intelligent answer as to how exactly the BoC rate decisions affect the 5-year bond rate. I can cop out and say that there are all the providers of capital choosing what rate they'd accept to lock in for x amount of time vs lending floating (BoC or LIBOR + a spread) and all the borrowers making the same decisions from the opposite side, and it sorts itself out.


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## GeniusBoy27 (Jun 11, 2010)

In general, historically the variable rates are better than fixed rates about 90% of the time. So there are points where fixed may better, but timing this is difficult.


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## ThomasBeyer (Apr 22, 2011)

*variable always lower, on average*

On average, variable rates are always lower than fixed rates.

Fixed rates are like an insurance, as banks do not know where rates will be in 2, 4 or 5 years. Therefore, they have to charge a risk premium for this "insurance".

We locked in 2 large mortgages for 2 of our apartment buildings for 10 years, one in 2005 at 5.5% and one in 2007 at 5.2% because we thought rates would go up. Guess what, they have been lower even since and we would have saved with either a 5 year or a variable term.

Hence: go variable and have a cushion of cash for those rare times variable rates may spike.

Go fixed ONLY if you are maxed out with your payment and cannot afford a rate spike.

On average, over a 5 or 10 year period, variable rates are ALWAYS lower and you save a lot of money !!

Thomas Beyer


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## arie (Mar 13, 2011)

*variable vs fixed*

as has been said its based on your ability to withstand increased payments should the rates rise

the chance of the prime rate going lower is next to nil

we are near the lowest prime rate and it can only go up from here especially as the latest stats show inflation

based on the above i would negotiate a good 5 year fixed rate ; you will pay more now but if as i suspect the rates rise you will pay lower rates later ;although i must admit i thought the interest rates would have risen earlier --- it all depends on inflation fears and what happens to the american economy 

its a look into the future which no one has a crystal ball for


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## Financial Cents (Jul 22, 2010)

@arie - true, the chance of the prime rate going lower is next to nil but they haven't exactly gone up as "predicted" either. Man, just thinking about this makes me annoyed; I really dislike "experts" - they really have no clue. 

I admit too, I thought interest rates would have risen earlier, at least 25 basis points in the fall of 2010.


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## andrewf (Mar 1, 2010)

If you get a fixed rate mortgage for 3.5 or 4%, rates will likely have to rise by nearly 3 pts in the next couple years to break even vs. a variable mortgage. Sure, that might happen, but I'm guessing prime won't be at 6% in five years.


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## Financial Cents (Jul 22, 2010)

@Andrew - I agree with you, prime won't be back to "normal" for another few years. I wouldn't be surprised if prime doesn't go up 50 points before the end of 2011 though.


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## Echo (Apr 1, 2011)

@Financial Cents
I don't think anyone can fault you for taking the fixed rate back in December. All signs were pointing towards a series of successive increases this year. Now it doesn't look like there will be an increase for a while. Maybe 25 or 50 points this year, but no big deal.

I'll have to renew our mortgage when we move into the new house in August and I'm definitely sticking with variable rates, but I'll adjust my payment to reflect a rate around 4.5% or 5%. The key is to get the variable at prime minus .75 or .8 if it's available.


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## financialnoob (Feb 26, 2011)

Financial Cents said:


> I'm totally kicking myself right now. We closed on our house in December 2010 and got a 5-year fixed rate for the "insurance". Well, rates still haven't gone anywhere despite "expert" promises they would.
> 
> In hindsight, I've learned my lesson: I will never go with a fixed-rate mortgage again. I'll go variable.
> 
> The "experts" don't know any better than anyone else what the future might hold.


While I agree with your last line, I wouldn't kick yourself too hard yet. You got the 5-year for insurance, but it hasn't even been 5 months yet and you're regretting it. It's like investing for the long-term but getting caught up in every up and down. If there are increases in the next 6 months, that may change how you feel about it.


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