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Rob Carrick

For the cheapest mortgage, go variable Add to ...

The smart money’s long infatuation with the variable-rate mortgage has ended, perhaps a little hastily.

A lot of homeowners have saved a ton of money with variable-rate mortgages, where your borrowing cost floats with your lender’s prime lending rate. The prime rate is in turn guided by the Bank of Canada’s overnight rate, which was pounded lower in the financial crisis of 2007-09 and hasn’t rebounded. And yet, for reasons that may not be entirely sound, the popularity of the variable-rate mortgage is in decline.

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The main argument today against going variable is that the usual cost advantage over fixed-rate mortgages has declined to a small fraction of what it once was. Given all the financial uncertainties of today, many borrowers are happy to pay a nominal premium for the certainty of knowing they have locked in payments that would be unaffected if interest rates rise.

Will rates actually rise any time soon? “I just don’t see it, no,” said David Larock, a mortgage broker and ex-banker who recently did some hard thinking about his preference for fixed-rate mortgages in today’s environment.

What he decided was that global economic weakness will keep rates low for years, and that means variable-rate mortgages are still a viable choice. Mr. Larock said he’s able to offer his clients five-year variable-rate mortgages at prime minus 0.4 percentage points, or 2.6 per cent, while banks and some other mortgage brokers are in the range of 2.8 to 2.9 per cent. Five-year fixed-rate mortgages can be had for 2.99 per cent, including discounts.

Historically speaking, today’s spread between fixed and variable rates is a joke. The gap between variable-rate and fixed-rate mortgages in 2010 and 2011 averaged about 1.7 points, the Canadian Association of Accredited Mortgage Professionals said in its recently released annual consumer study. Mr. Larock said variable-rate mortgages have been cheaper than five-year fixed-rate mortgages 90 per cent of the time over the past 25 years.

“There’s always a chance that now might be one of those rare, exceptional times when a fixed rate saves you money, but you’re taking one-in-ten odds that you’re right,” he wrote in a recent blog post.

The big game changer for variable-rate mortgages was a pricing change introduced by the banks a couple of years ago. Where once they offered discounts of as much as 0.75 to 0.9 of a point off prime, the banks began to sell these mortgages at prime plus or minus a bit.

Mr. Larock said the vanished discount is a big reason why people have stopped favouring the variable-rate mortgage. “But if you look at it just in comparison to other options, it’s still the cheapest way to borrow money.”

CAAMP’s consumer study shows that the percentage of mortgages with a fixed rate rose to 65 per cent this year from 60 per cent last year, while variable-rate mortgages fell to 28 per cent from 31 per cent (hybrid mortgages make up the difference).

The move away from variable has been strongest among people buying homes this year; some people have also been converting variable-rate mortgages to a fixed rate, known as locking in.

The variable-rate skeptic will say that interest rates are at absurdly low levels by historical standards, and that rates can move sharply higher and still be in line with historical averages. This view is supported by all the stimulus injected into the global economy by central banks in the past several years. Eventually, it could cause inflation to snap back from today’s moribund levels.

Mr. Larock does see inflation making a comeback, but not any time soon. The bond market certainly isn’t suggesting higher rates.

The yield on the five-year Government of Canada bond, benchmark for fixed five-year mortgage rates, is pretty much where it was 12 months ago and well down from the 12-month high reached in March.

Another angle on this variable-versus-fixed-rate debate is something we’ll call financial uncertainty fatigue. It may just be that people are more open to five years of interest rate certainty than they were before as a result of all the financial and economic ups and downs of recent years.

The premium for mortgage rate certainty is minimal right now, and thus a good buy for many borrowers. But for the cheapest mortgage, go variable.

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