Fixed vs. Variable Mortgages: Which One Should You Choose With Peaking Interest Rates In Canada?
Introduction
Interest rates have gone up, rents have gone up too, but let’s face it, rental cash flows are getting hit still for landlords, especially if their tenants haven’t changed recently.
Now, fixed rates are looking much better these days, and so they do seem like an easy choice at first glance. But wait, you might also be aware that economists are predicting that interest rates to come down in the next year, so you definitely want to take that into account when making your decision.
There could be other factors playing into your decision-making process, especially if you’re thinking of changing up your existing mortgage and that’s exactly what we’re going to break down for you.
Traditional Choice For Investors
Before rate hikes, variable rates were definitely the more popular choice. They offered a sizeable discount over fixed rates even if you take into account expected future rates. Payments were also lower at the start, which meant people could qualify for bigger loans, and they were also more flexible if you needed to break the existing mortgage and refinance your property.
Even when rates started to go up, not many people expected them to rise as much or as quickly as they did, and people were still choosing variable mortgages.
What Should You Choose If You're Getting A New Mortgage?
But now, things have done a 180. Fixed rates are now lower than variable rates, and so if you wanted lower payments and to qualify for a bigger mortgage, then fixed rates are now the way to go.
Currently, the best 3 year fixed rates are around 4.8%, while variable rates are at 6%. Nobody can say for sure where rates will be next year or the year after, but if we go by forecasts from the big banks, it looks like rates might drop by 1.5% next year and 2% the year after. So if you take an average of these rates, it comes out to a pretty similar 4.8% average variable rate over the next 3 years, which is pretty much what fixed rates are at these days.
In other words, that discount that you normally get with variable mortgages isn’t around anymore even though you’re technically taking on higher risk, and you’ll get higher starting payments from the start with a variable mortgage.
Sure, rates might drop more than expected which could make variable rates end up better, but it’s just as possible that rates won’t drop as much as expected, which could also make variable rates look worse.
So when you think about it, if you’re getting a new mortgage, it might be better at this point to stick to a 2 or 3 year fixed rate since the expected returns are the same, but you eliminate the uncertainty, which basically makes fixed rates a better risk adjusted choice.
As real estate investors, we like to have options and flexibility. So if you choose a longer 5 year fixed rate, it might actually limit your choices down the road if you want ti refinance or expand your portfolio. That’s why we still prefer a shorter fixed term. That way, you’re balancing lower risk during the more uncertain times over the next few years with more freedom in the future.
What Should You Do If You're On A Variable Mortgage Already?
Now if you have an existing variable mortgage, and you’re thinking of switching out of it into a fixed rate mortgage, then you actually have a few more things to think about.
The first thing is the penalty for breaking your mortgage, and this can vary from lender to lender. Most variable mortgages charge 3 months of interest if you break it, and that could make a big difference in whether or not to make the switch. If you’re paying 6% on your variable rate, that’s a 1.5% penalty which is big, and that would mean making the switch isn’t really worth it anymore.
The good news is that if you stick with your current lender, you might be able to treat it like porting your mortgage and that means you won’t have to pay any penalties. This changes everything. And then, from a net income perspective, its’ the same story as getting a new mortgage. You have similar expected interest rate expenses by making the switch but you end up reducing your risk, which can make it a smart move to improve your net income.
But don’t forget about cash flow. Even though switching to a fixed rate mortgage may yield better risk-adjusted returns, it could still negatively impact your cash flow if you’re currently on a variable rate mortgage with interest-only payments that have already hit the trigger rate.
Let’s say you have an $800,000 mortgage with 6% interest-only payments, which costs about $3,900 per month. If you switch to a new 4.8% fixed rate mortgage, you’ll have to add back the principal paydown each month, which means your monthly mortgage payment will increase to around $4,200 – and that’s obviously higher than before from an outgoing cash flow standpoint.
So if cash flows is the most important thing to do, then sticking with your current variable mortgage might actually end up being better. Better holding power may then translate to being able to more comfortably hang onto your investments, which could end up being the more important factor for long term real estate investing.
How We Can Help
Everyone’s situation is unique, so the decisions you make about your mortgage should reflect that. Optimizing your real estate portfolio is crucial if you want to grow your wealth through investing, and that’s where we come in. We’re a real estate brokerage based in Toronto, and our core focus is to help investors like you navigate the complex world of real estate investing in Toronto.
Our goal is to make real estate investing as easy as possible for you, which is why we offer a range of services to support you throughout the entire investment process, from planning and analysis to sales, renovations, leasing, and property management.
So if you’re interested in learning more about how we can help you, we’re happy to chat with your privately with you to learn more about your situation.
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