Scott Dillingham: 00:21

Welcome back to today's show. Today, I'm gonna go over another heavily debated topic that people cannot choose or cannot easily choose what way to go. And that would be, should you get a fixed rate mortgage or a variable rate mortgage? And there's so many possibilities and options with each one. I'll dive into them.

Scott Dillingham: 00:42

We'll go over the pros and cons of each, what most people are selecting. And then we'll, hopefully, after the show, you'll be able to make your educated decision on which rate you should get. So let's talk about the difference between the fixed and the variable rates. Very high level, a fixed rate is a term that you select. It can be from pretty much 1 to 10 years.

Scott Dillingham: 01:06

You select the term that you want, and your interest rate is locked in for that period of time. Okay? So a major benefit to the fixed rate is it gives a homeowner the comfort of knowing exactly what their interest is gonna be for the next however many years based on the term that they select. The variable rate on the other hand, the variable rate can fluctuate over time. So historically, and I'll touch on the historic rates, but historically, the variable rate is the lower priced option to go with.

Scott Dillingham: 01:37

But the variable rate raises with the prime rate. So the government of Canada sets the prime rate. And during COVID, it's been artificially lowered to help spur the economy and keep things going. But as soon as COVID's done, I'm sure it's gonna go back up to pre COVID levels. But the variable rate goes up and down based on what the economy is doing.

Scott Dillingham: 02:00

Now it's never it raises 3, 4, 5 percent in the year. It's never like that. When they review the variable rates, so they can review them, There's actually many times per year that they review and they determine if they should raise the variable rate, lower it, or keep it the same. And when they do, they consider the whole economy because so many things are tied to the variable rates, such as car loans, credit cards, lines of credit. So the variable rate, it's not something that they like to raise, but if the economy is booming, they will raise it.

Scott Dillingham: 02:34

And your payments and your interest owed can fluctuate. Now, let's talk about the penalties for each. If you get a fixed rate mortgage, the penalty on that is either going to be 3 months interest, or it's called IRD, which stands for interest rate differential, whatever is greater. So with the fixed rate mortgage, usually it's the IRD is is the penalty, and every lender has their own way to calculate it. I know in another episode, I spoke about how some lenders calculate the fixed rate penalty based on the bank's posted rate, which is their non discounted rate.

Scott Dillingham: 03:14

Some lenders calculate the penalty based on the discounted rate, which means your penalty is smaller. But all in all, the fixed rate mortgages, they do have a higher penalty than a variable rate mortgage. So with the variable rate mortgages, it's quite low and simple actually. It's just 3 months interest is your mortgage penalty. In both cases, you'll have a discharge fee, but I'm just referring to just a penalty here.

Scott Dillingham: 03:41

It's just a 3 month simple interest penalty. It's easy to know and to be able to calculate what your penalty is. So if you're somebody that this is your dream home and you're not gonna move and you're scared about what the rates are gonna be doing, I might suggest, fixed. But if you're somebody that you're not sure when you're gonna move, what's gonna be soon, and you just don't know, then then I might actually suggest going with the variable rate. Even if you're concerned with the rates going up and down, but just for the flexibility that it gives you, and knowing you'll have the smallest penalty.

Scott Dillingham: 04:14

Now sometimes it's possible that your mortgage lender will allow you to port your mortgage. So even if you have a fixed rate mortgage, you're not having a penalty, but not in all cases. There's people that are military based service members that are getting rid of their mortgage and they're being stationed overseas. People moving to a different location, and possibly that lender doesn't provide mortgages in their new location. So there's, even though porting is an option, it doesn't mean you can port your mortgage every single time.

Scott Dillingham: 04:42

So there's blackouts in that. The variable, if you're uncertain of what's gonna happen to you, but you know that you're not gonna live in the house for a long period of time, I would recommend the variable, because it's got the smaller penalties. Now there's so much there's so much more to it than that too. So we're gonna talk now about payments. So if somebody comes to me and says, I'm looking for a mortgage with the lowest payments.

Scott Dillingham: 05:09

Initially, I would recommend the variable rate because the variable and I'll give you a couple examples. These are obviously I'm recording this in January of 2022. The rates, whenever you hear this, it's gonna, can be different. But the variable rate right now, we've got some lenders as low as 1.25, where the fixed for 5 years is around 2.34. So it's more than 1 whole percent difference.

Scott Dillingham: 05:35

So the variable rates will give you a lower payment. Right? So for the same purchase price, you will have a lower mortgage payment with the variable than the fixed. It just comes down to your level of what you look for in safety for the mortgage. Do you want to accept a lower rate today, which gives you a lower payments knowing that it could go up?

Scott Dillingham: 05:57

Or would you rather have that higher payment and accept the higher interest, but no, it's not gonna change? Depending on what you're looking for in your payments, the variable might be better or the fixed might be better. Everybody's scenario is different. Now another cool thing with the the variable rate that I like is that it allows you to prepay extra more so than a fixed. So usually the fixed mortgages, you can do annual lump sum payments of anywhere between 10 to 15% of your original mortgage amount.

Scott Dillingham: 06:33

But with the variable rate mortgage, you can actually pay between 15 to 20 percent of your annual, original mortgage amount annually. So if your goal is to pay off your house as fast as possible, then again, I might suggest the the variable. I'm not sure if you can tell. I do actually prefer the variable over the fix. That's the one that I've chosen for all of my properties and, you know, what I would continue to choose.

Scott Dillingham: 07:02

But there's many clients and many scenarios where I will tell them I don't recommend that you get the variable that you should get the fixed. So everybody's different, but I just want you to know the pros and cons of each. So when you're faced with a decision, you can make the best decision for you. Oh, beyond the the prepayments, the variable is flexible as well when you do sell. I know we we touched on porting the mortgage and whether that's available or not.

Scott Dillingham: 07:29

But the variable rate, they don't port them. So I want you to know this, they don't allow you to port, but what they'll do is when you sell, you you get charged the penalty. And if you stay with the same lender and your mortgage amount is at least the same or greater, then they'll refund you your penalty. But it's only within a certain amount of time, so you wanna make sure what that timeline is before you sell and buy to make sure you're within that allotted time, so you obviously get your penalty back. Now I've got to take a quick pause, but when I come back, I'm gonna talk about some of the history about the rates, what they've done, and where I think they're gonna go next.

Scott Dillingham: 08:07

Alright. Welcome back. I think if you are a real estate investor, I do think that you should go with a variable rate for sure over the fixed. Again, we discussed the benefits with the, or payments, better prepayment for real but for a real estate investor, you just never know if you need to sell. You don't know if there's gonna be another down the road and you wanna get rid of this property and upgrade it.

Scott Dillingham: 08:32

So for an investment standpoint, I love the variable because it gives you that easier exit strategy to get out of the mortgage. Another misconception with the variable rates is that when you have the variable rates and the interest rate is going up, when it increases, it only increases by a quarter of a percent at a time. And then they'll check the next review period. They'll check and see how the economy is doing, and if they should raise it again, keep it the same or lower. And there is that misconception that variable can go from ones like it is now to 5 overnight.

Scott Dillingham: 09:09

It would never do that. It does that in increments. So if you compare today's variable rate compared to the fixed, it would have to actually increase 4 times before the rate is even close, it would still be cheaper than the fixed if it went up 4 times. So that's huge. A lot of people don't think of it that way.

Scott Dillingham: 09:30

And when they hear the rates are going up, they get scared. But you don't need to. Even if the rate goes up once or twice, you're still better. So let's say it goes up twice. Right?

Scott Dillingham: 09:39

And you sign up and you get 1.25 today. When they increase it, it's usually by 0.25. So if the rates went up twice, and you got today's variable rate, it would equal 1.75, which is still a lot less than the 2.34 that I could offer you today. Another cool thing with the variable is that you can lock it in. So say you've got the variable, it's went up a couple times, you think it's gonna go up more, and you're fearful of that, and you don't, you know, you don't want it to.

Scott Dillingham: 10:12

So you can then call your lender, and you can lock it into a fixed rate. There should be no fees or penalties to do that. The lenders we work with, they allow that service at no cost. So if you're a lender or you're hearing that your lender might charge a fee, and maybe that's not a good lender, you should potentially look at getting your mortgage somewhere else where where you're not gonna be charged for basic services, but that is something that's available to you. So you're not always stuck.

Scott Dillingham: 10:41

Now you can't go from a fixed to a variable because fixed you lock in. So you're absolutely locked in. The other stat that's out there is the average time a homeowner keeps their mortgage, not necessarily buys or sells, but keeps their mortgage is three and a half years. So everybody wants to get the 5 year fixed. That's the most popular fixed product.

Scott Dillingham: 11:05

But it's proven time and time again that the average mortgage is only 3 and a half years, and then someone refinances it. Maybe they do an addition. Maybe they need to pay off debts. Maybe they want to invest, and they're pulling money out for down payments for rentals. When you get the fixed, and you don't look at the overall picture, and you can't foresee and predict what life's gonna bring your way, does, tie your hands if you need to pull out equity.

Scott Dillingham: 11:31

You've got you're gonna have that mortgage penalty. What I suggest is if you're gonna get the fixed, and you've got a down payment that's larger than 20% down, I would actually recommend that you get a line of credit as well. So you still borrow up to 80% of your home, but you get your mortgage for what you need, and the balance will be line of credit. That way, if there is an emergency and you need access to quick cash, you can get it without having to refinance your mortgage, but then you're not paying a penalty. So that's one way you can save if you get it fixed.

Scott Dillingham: 12:03

And obviously above all, if you are that type of person that is very fearful of the rates going up and down, your payments going up and down because you're on a fixed budget, and you wanna know exactly every month what your payments are, then 100% go fixed. Because you don't want to live with that fear, And I've seen some clients incredibly fearful. They their friends and family, everybody was saying, oh, get the variable, and they did it. They didn't like it, and then then they locked into the fix right away. You don't wanna have that fear of being in the wrong mortgage because the mortgage is the biggest thing that you're gonna buy in this lifetime.

Scott Dillingham: 12:37

So you wanna make sure it's set up properly. Now just to touch on the history of the rates. So you can go to Google, and Google fixed versus variable rates for the past 25 years. A really good lender, CMLS Financial. They, have this article out there, and you can open it.

Scott Dillingham: 12:55

It's like a downloadable PDF, and you can see the past 25 years, the fixed versus the variable rates. For the fixed and variable, we're the same, at least the same rate. It looks like 1, 2, 3, 4, 5, 7 times for a couple of months over the past 25 years. Beyond that, the variable rate has always been cheaper. So I know rates have went down because of COVID, And I know once COVID disappears, rates are gonna go up, especially if inflation keeps going the way that it's been going lately.

Scott Dillingham: 13:28

The rates are going to go up. So these rates that I'm gonna talk about are gonna sound crazy, but they could be back one day. So you just never know. But so in in 1995, the fixed rate was around 11%, the variable rate was around 9 a quarter. So there was quite a bit of a spread.

Scott Dillingham: 13:50

And then obviously, now today, we know it's 1.25 versus 2.34. But if you look at the curve of it, the rate they came down quickly and they've flatlined. And I know pre COVID, they actually were going up. They're starting to go up. Like, fixed rate mortgages were in the threes to almost 4% range pre COVID, which is a lot more than they were when, we had the, the bad recession of 07 and 8, and the rates plummeted, then they're starting to slowly creep up.

Scott Dillingham: 14:21

And again, they've lowered because of COVID. So my prediction is if COVID disappears or the economy has a hyperinflation, then the rates are definitely gonna go up. So when they're raising like crazy, it might make sense to to lock in. But if it's an investment property, it's still probably go with the variable just for your exit strategy. But if you look at the the history, so the average of over the 25 years, the fix was about 5.75 and the variable was almost 4 and a half from the looks of this chart.

Scott Dillingham: 14:55

So you could check it out. It has all the rates for every single year. You can see when there was a recession, When they lowered the rates, you can see all of this stuff. But if you look at the variable and you look at when they increase it, it looks like a step ladder. Like, they do it in stages.

Scott Dillingham: 15:09

So that's what I mean. It never goes up overnight just instantly. It's done in stages. But when they lower the rate, like when COVID started, you'll see it just go straight down because they instantly lower it. So you'll see a bunch of them when they lower, they drop substantially and immediately.

Scott Dillingham: 15:26

But when they raise, it's done in steps. And again, that's because everything's tied to not everything, but tons of things are tied to variable. And they don't wanna hurt the economy when they raise the rates. They only wanna raise it if the economy can support it. So there's so many things to think about, but I think at the end of the day, if you're someone who's incredibly fearful or really strict on your budget and you have to be for various reasons, then I would go with the fixed.

Scott Dillingham: 15:53

But if you're someone who's a little bit more flexible or wants those lower payments, I would absolutely go with the variable. Like I said, every single property that I've ever done, I've always got the variable. There was one that I renewed into a fixed because the fixed rate was just too good. I couldn't pass it up. But beyond that, it's always been the variable.

Scott Dillingham: 16:13

And even when it's went up, I've been okay with that. And I've even had the same mortgages that went up during those rate increases, and then they went down. Because the variable rate does go down too, even when COVID's not around. If the economy is not strong or not where they want it to be, then they'll lower the variable rate to spur, the housing market and purchase it and get things going. So it does go down as well.

Scott Dillingham: 16:34

So I know there's fear of it just going up, but it can go down. Lots to think about, but I hope this conversation with you was able to help you to choose what one is best for you and your family. And then I look forward to chatting with you in the next episode.