The Disappearing Variable Rate Discount

The days of deeply discounted variable rates seems to have disappeared. Over the past month lenders have been slowly reducing their discounts from as low as P-.80% to now prime and prime plus. There are still a few holdouts -- lenders who most likely see an opportunity for some quick deals -- but it probably won’t be long until those gaps are totally closed.

Fixed rates, on the other hand, can be had for as low at 3.39% on a 5-year term (at the time of this writing). When spreads are this tight, it’s no wonder that industry insiders are reconsidering all the research suggesting that variable rates are the way to go.

Variable rates have been the most popular choice among homeowners between the ages of 35 and 44 according to a report from Canadian Association of Accredited Mortgage Professional (CAAMP). While there is always a risk that interest rates will fluctuate, there are other factors to consider. The greatest advantage is the long-term savings on interest costs. Research has shown that people have saved money on variable-rate mortgages more than 80 per cent of the time.

Online mortgage news source Canadian Mortgage Trends recently interviewed Benjamin Reitzes, Senior Economist for BMO capital Markets who said borrowers won't see the same advantage to variable rates as they have in the past 25 years because the prime rate, which is sitting at 1%, can’t drop 1% -- there is room for a slight cut, which some economists say may happen in 2012, but the stronger likelihood is that rates will start to slowly climb in the latter part of next year.

Much of the reasoning for preferring variable over fixed is, of course, the interest savings. When we take a look at the spreads between fixed and variable rates between 1970 and 1995, there is a difference of 126 basis points compared to the average difference today of 50 basis points. That translates into a lot of savings.

Although the spreads have been reduced and discounting is disappearing, what hasn’t changed is a home owner’s decision-making process. When variable rates were historically low and fixed rates were substantially higher, many home buyers opted for fixed because they knew exactly how much principal and interest they paid on each regular mortgage payment throughout the term. And for some, having that peace of mind is the determining factor.  

So the question of whether going fixed or variable still comes down to what makes a home owner comfortable. However, it’s really a win/win for home owners -- with fixed rates so low, and with the prime rate increasing some time in 2012, the fixed rate may indeed outperform the variable rate, but even if it doesn’t, the extra interest costs on fixed rates will be far less than in past years.