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Fewer Buyers Opting for Variable Rate Mortgages

Fixed Mortgage Rates Lock inOver recent years, banks have been trimming the interest rate differential offered for variable rate mortgages. Not surprisingly, the percentage of buyers now chosing variable mortgages is dropping. The new belle of the ball is the old standby. That's right, the boring, bland, fixed rate mortgages have become Miss Popularity.

Why have fixed rate mortgages become more tempting to more daring mortgagees?  Well, that's because home owners who gambled on a variable rate mortgages are no longer seeing enough upside. 

Let's go back to the basics of why, despite the uncertainty, variable rates were appealing to these mortgage mavericks in the first place. They chose variable mortgages mainly for three reasons:

     1.  They were more risk tolerant
     2.  Interest rates on variable were generally significantly lower than fixed
     3.  They were gambling that over time the average variable rate mortgage would be
            lower than the fixed and they will save money

So let's deal with the risk aspect first.  The risk involved in a variable mortgage is that if a home purchaser choses the lower variable rate, then the interest on their mortgage can change up or down with no warning. They have the option to lock in later, but if the rate goes up and they chose to lock in to a fixed, then the rate will be higher than if they had chosen to lock in before the rates increased. Also, their ability to negotiate a fixed rate is bootstrapped because they are already on contract for the variable mortgage to their financial institution. 

Despite this risk, buyers that have chosen variable rate mortgages have, in most cases, saved money over the course of the mortgage given the interest rate spread (lower variable than fixed rate) and the stable interest rates we have experienced.  "Anyone who would have selected a variable-rate product over the last 10 years will have done very well" says John Turner, director of mortgage at Bank of Montreal in Toronto".  


Let's move on to the second reason; the interest rate differential.  As they say, all good things must come to an end. Well, in this case, not exactly an abrupt end; but just not such a good thing anymore. Up until a few years ago, variable rates were at either prime, or prime minus. Now they are at prime plus. The interest rate spread between a variable and fixed rate mortgage has narrowed. This in effect, has decreased the upside of variable rate mortgages.

Mortgage interest rates increasingThe third reason is the gambling on the interest rate differential in favour of the variable rate. If you had five advisors, all with doctorates in economics, you will still not have a lot of luck timing the market. It's very difficult to predict when interest rates are going to change and by how much.

Many buyers are now less tempted by the variable rate mortgages and opt for the security of fixed. If you take this week for example, the difference between the best five year variable and the five year fixed, is that the variable rate is about .5% less.  This is significant but with interest rates so low, mortgagees are realizing the bottom is close. The reason that you would pick a variable over a fixed rate is that you believe over time that the variable rates will average lower.  How much lower can interest rates go?

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