- Hey, welcome back.
It's Nolan Mathias and today
we're having a mortgage battle, that's right.
We're putting the five-year variable
against the 10 year fixed.
And I think at the end of this video
you're gonna be surprised which one I recommend
or maybe you won't because you've watched my other videos.
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Okay. So let's get into it.
Let's discuss five-year variable versus 10-year fix
because this is very much a conversation around a burden
the hand versus two in the Bush.
And one thing that my mother always taught me
she was a banker for 47 years, very intelligent woman.
She always used to tell me, lock in your savings
and lock in your returns whenever you get the chance
because once you've locked them in
nobody can take them away from me.
And I think that's going to be true for this conversation.
The question is going to be though
whether it makes sense to lock in the returns
on our variable rate versus take a gamble
on a 10 year fixed rate and hope
that interest rates go up enough in order to make it
worth taking that higher rate longer-term 10-year fixed.
Okay. So as usual, we are gonna make the math as simple
as possible in the scenario
because simple math leads to simple decisions
and difficult math just leads to confusion.
So we wanna make this as simple and easy as possible.
So we need to start
by understanding what the interest rates are now.
As of right now
you can get a 10 year fixed mortgage at 2.24%.
We're gonna call it 2.25% for that easy math purpose.
And you can get a five-year variable at 1.5%.
So the difference between these two rates as of today,
January or I guess it's February 3rd, 2021 is 0.75%.
So what that means is that the difference
between those interest rates is $750
per year for every a hundred thousand dollars in mortgage.
And what we're going to assume is
that the Bank of Canada has told us the truth
and they have basically given us
forward guidance that we can rely on.
And that's the interest rates are going to remain the same
into the middle of 2023.
So that gives us basically until July of 2023 to pay 1.5%
if we take a variable rate
and we're gonna use a simple number
of 500,000 for a mortgage amount
because that seems to be about the average mortgage
the customers are getting right now across Canada.
So what that means is that for an average borrower right now
taking a variable over a fixed
for at least the next two years is going to save you
about $4,250 a year or $8,500 for the next two years
for that timeframe where the Bank of Canada has said
that interest rates are going to remain low.
So we know that the savings that we're locking
in on a $500,000 mortgage is about $8,500
but then the question becomes well,
what do you think is gonna happen
to interest rates in 2023 when they start to go up?
And the good news is we have some pretty
reliable data that we can use as a comparison for this
because back in 2009 interest rates, as all of, you know
went pretty much to near zero, like they did recently.
And that was because of the financial crisis.
And then over the next few years
they started to increase a little bit here and there.
But the big jump was in 2017, specifically in July of 2017
when interest rates started to rise
and they rose over a 15 month period, 1.25%
and we're gonna use basically a 15 month period
with an increase of 1.25% in order to try to figure
out whether a 10 year fixed rate now makes more sense
than a variable.
So let's assume that we make it to the middle of July, 2023.
We're gonna have interest rates that remain the same.
We're gonna cruise,
we're going to lock in that $8,500 of savings.
And then interest rates are going to start to go up.
And we're gonna use that July of 2017 as an example
because between July of 2017 and December
of 2017 interest rates went up by half a percent
but we're actually gonna go one step further
and we're gonna make this a worst case scenario.
And we're gonna assume that interest rates actually go
up faster than they did in 2017.
So we're gonna assume that in July
of 2023 interest rates are gonna start to go up.
And by December of 2023, they're going to be increasing
by three quarters of a percent, which puts us at 2.25%
on the variable rate that we chose today.
So what that means is it basically is gonna
take us three years to get to even
which means we're going to have that $8,500 worth
of savings locked in.
And then our interest rate is going to be the same
as what we could have chosen
on a 10-year mortgage way back in 2021 or today's date.
So we've locked in that $8,500 worth of savings.
That actually is probably a little bit more
than $8,500 because we had that extra six months leading
up to July that we're going to have low interest rates for.
And then we're going to assume
that over the course of the next year
interest rates are gonna go up by another half a percent.
So basically what's going to end
up happening is we're going to ride
out three years of savings and then potentially
be in a situation where the last two years we
might have to pay an extra half a percent.
Now, what that means is that we're gonna have
to pay an extra $5,000 over those last two years.
So simply by choosing the variable rate over the fixed rate
in the first five years, we're gonna save about $3,500.
And that of course, puts us into a renewal scenario.
Now, if we were new at that point in time
and we have to renew into basically 2.75% interest rates,
yes, we're gonna spend the next five years paying
at a higher interest rate
and that isn't necessarily the best strategy.
But, because we had a variable rate,
we had the right to lock in.
And when we saw interest rates get close
to that 2.25% interest rate, we could have made that choice
at that point in time to say, okay, done with the variable
we're gonna lock in at 2.25%
and therefore we're locking in our savings.
And we're gonna basically lock
in that low rate for the next five years
which is going to give us basically an eight year runway
at the lower interest rates with the locked in savings
rather than paying that premium
for the 10 year fixed for those first two or three years.
And then hoping that interest rates went up.
Now, could interest rates continue to go up
and we end up being worse off
because we chose this variable rate strategy
because we aren't able to lock in those last five years
at as low-level rate
as what we were able to get on a 10-year mortgage.
Well, yeah, that is definitely a possibility
but here's the reality of what happens when
we get into a low interest rate environment.
Is it takes a very long time for an economy to climb
out of a low interest rate environment.
Which means that in all likelihood
when interest rates do start to rise, the central bank
as central banks do is probably going to overshoot
raise interest rates too much
and then end up having to bring them down.
Which means it could take a very long time
for us to get out of this low interest rate environment
and the chances of losing by taking a variable rate strategy
on a 10-year become even less.
And there's evidence to support this.
If you go back and you look
at the 1930s to basically the 1960s,
it took 25, 30 years for interest rates
to increase by just 5%.
And if you go and you look at Japan in the 1990s
when they went to 0% interest rates
and you look at them 30 years later,
they're still at 0% interest rates.
So there's a high likelihood just because of the fact
that it takes economies a long time to climb
out of low interest rate environments that you could end
up having a scenario where interest rates remain low
for the next 10 years.
And that you absolutely do benefit
because you took a variable rate over a 10 year.
So from my perspective,
even if interest rates do start to go up,
locking in those savings early
and paying off your mortgage a little bit faster
is definitely something that makes more sense
to me than taking a longer term mortgage
and hoping that interest rates go up
at a rate that is obviously beneficial
to you because you chose a 10 year mortgage.
Now is there a scenario
where I might consider a 10 year fixed?
Absolutely. And that is a case where a client comes in
and is so risk averse, that they cannot fathom
having the prospects of having a variable rate mortgage.
They don't wanna think about their interest rate going up,
they don't want to lose sleep over it,
so therefore they decide that they want a
five-year fixed mortgage instead.
Well, in that scenario
my concern is that a five-year fixed
could end up causing a client to have
to renew into a higher interest rate
in five years causing payment shock.
So if I could get them a 10 year fix that is
close enough to a five-year fixed
and isn't gonna cost them a significant amount
more money in order to take that longer term mortgage
I may encourage them to do so,
so that they don't have to worry about payment shock
in five years.
And that is the one scenario quite simply
where I think a 10-year comes into play.
My two picks right now
for a mortgage would be a five-year variable
or a 10 year fixed for a really, really
really risk averse client.
But I'm still doing my best
to avoid five-year fixed mortgages
because I do think there's a pretty significant risk
of having to renew into a mortgage
that is 1.25% higher in five years
which could cause that payment shock.
By the way, one thing I love about a variable is
if interest rates do start to rise, you feel the increase
in payments gradually over time,
rather than all at once at renewal,
which I think is a very good tool
for helping people manage their money
and handle a scenario where interest rates are
actually increasing over time.
So if you found this video useful, do me that favor hit
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So we'll see you on the next video.
Hope you enjoyed this one
and hope that you have a good rest of your day, cheers.