Have Your Cake...

Have your cake and eat it too: A variable rate mortgage where payments are “fixed”.

I consider myself to be a smart person who sometimes does dumb things with money. Five years ago I signed up for a variable rate mortgage (smart), but as interest rates declined over the last few years my payments declined too (dumb). This was dumb because I could afford the higher payment and did nothing with the money that I was saving on interest every month. I only realised this as I sorted out the details of my mortgage renewal and learned that there was a simple way to have your cake and eat it too.

The case for variable rate over fixed rate mortgages is pretty compelling. You’ll pay less interest on a variable rate mortgage than a fixed rate mortgage almost 90% of the time, according to York University finance professor Moshe Milevsky. The downside is that as rates change, so will your monthly mortgage payment. This isn’t a problem when rates are falling, except if you do nothing with the savings like I did. But when rates are rising a higher mortgage payment can be tough to handle, both emotionally and practically. Certainty on what the monthly payment will be is one of the main reasons why so many people choose a fixed rate mortgage, even though it will likely cost them more over time.

So how about a variable rate mortgage where the payments are fixed? If rates rise you’ll be paying more towards interest and less towards your principal. If rates fall, you’ll be paying less towards interest and more towards your principal. You get the benefit of a fixed monthly payment, plus you get the benefit that you’ll likely pay less interest over time. I’d recommend you have your mortgage provider come up with a payment based on a prime rate that is closer to the historical norm, say 5% or 6%. That way, when rates return to those levels you won’t suddenly feel a cash flow pinch. Until the time that rates hit that level you’ll be paying your mortgage down more aggressively and shortening your amortization period with every payment.

What variable rate did I get? Prime minus 0.70%. Not too shabby.