Variable rate mortgages allow borrowers to lock into a fixed rate at any time – preferably right before rates start to soar. That doesn’t make them the sound financial choice however and here’s why:
Timing Is Everything
Many of us think we will know when to lock in but the truth is, most don’t get the timing right. You have to follow the market consistently. Most people just don’t have the time to become interest rate analysts (and even those guys get it wrong!) Bond rates fuel the fixed mortgage prices and traders start raising bond rates (yields) well before Bank of Canada moves. Yields can rise quickly, signalling lenders to follow suit and promptly raise fixed mortgage rates. If your solution is to watch bond yields, here’s the problem with that – they spike randomly, faking everyone out before they settle back down. The result? You end up locking into rates that are one-half to three-quarters of a percent higher than your old variable rate.
Conversion Rates
Very few lenders give their best fixed pricing to customers who convert from a variable mortgage. Instead, they give their standard advertised rates or an unpublished “conversion rate.” These rates are usually at least one-fifth to one-half percent higher than what a new customer would pay. To make things worse, it’s hard to negotiate the conversion rate because lenders have the upper hand: they know you have to pay a hefty penalty to break your mortgage and figure you will be more inclined to pay a higher rate.
Term Limitations
When converting into a fixed rate, the majority of lenders will require that you choose a fixed term that’s at least as long as your remaining variable rate term. For example, if you have four years left on your variable mortgage, you can’t lock into a two year fixed mortgage. Even worse, some lenders only let you lock into a five year fixed mortgage. That’s a big problem if you need to exit the mortgage before those time lines (see the link above on Breaking Your Mortgage).
The Bottom Line
What it all boils down to is this…depending on your mortgage:
- your payments will most likely increase
- you will pay a penalty or a conversation rate to lock in
- you will pay a penalty for early termination (if you decide to go elsewhere)
- you may be forced to lock in to a longer term than your original variable mortgage
- you may be forced to lock into a fixed rate with refinance restrictions
What’s a Borrower To Do?
Make sure you discuss all your options with your lender and insist that they provide full disclosure of all costs and restrictions. Of course, make sure you get it in writing!
Originally sourced from The Globe and Mail
