- Hey, it's Nolan Matthias for Mortgage360
and today we're talking fixed versus variable rate mortgages
and how to choose the one that's right for you in 2020,
and at the very end of this video,
we're gonna give you the exact strategy
that we're using on our variable rate mortgages,
so stay tuned for that.
But before we get into it, do me that favor,
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So let's get into it, fixed versus variable rate mortgages,
how do we choose the right one for you in 2020
and when we talk variable versus fixed-rate mortgages,
we talk about two criterium primarily.
One is your risk tolerance
and two is what interest rates are doing at the time.
So let's talk first about risk tolerance
'cause that by all means is the most important thing
when it comes to choosing a fixed
versus a variable rate mortgage.
And you know obviously we aren't meeting
with clients face-to-face right now
but typically when we are meeting with clients face-to-face
in a non-COVID world,
now we're doing it over Zoom of course,
basically what we do is we will sit a couple down
across the table from us and we'll say,
how would you feel knowing that your interest rate
could increase overnight and subsequently,
your payments could also increase overnight as well?
And then what we'll do is we'll watch their body language
and typically in a couple,
there's usually one that's a little bit more risk averse
and one that's a little bit more risk tolerant.
So, we'll look at the one
who's a little bit more risk averse
and we'll kind of assess their body language
and how they feel about the prospect
of their interest rate going up.
And if there seems to be quite a bit of aversion
to a variable rate mortgage and that fluctuation,
we'll kind of hash that out
and we'll talk about worst case scenarios.
So what would happen if interest rates went up
by 1%, 2%, 3%, what would that look like
from a payment perspective?
And then we'd basically have them assess for themselves
whether it makes sense for them to take that variable
and whether they would be able to withstand the pressure
of an increasing interest rate.
Now you can do this at home as well because what you can do
is just go and find a mortgage calculator,
put in your mortgage amount,
put in your amortization, typically it's 25 years,
and then put in an interest rate
like what the interest rate would be today,
which is about 2.25%,
and then increase it by half a percent,
and then increase it by half a percent again,
and then a half percent again, and a half a percent again.
And then kind of figure out
where you start to get uncomfortable.
And if it's around, you know, a percent higher,
then variable rate's probably not the best thing for you.
If it's about 2% higher,
then you know maybe variable
might make a pretty good strategy for you
but if you start getting uncomfortable
at an interest rate that's three to 4% higher,
then probably not a good idea
to take a variable rate right now.
And we also want to make sure
that you're as comfortable as your partner
and your partner's as comfortable as you
because when it comes to mortgages,
I mean the number one thing
that breaks up couples is finances,
and you know Mortgage360,
we never wanna be in the business
of breaking up relationships,
like we're not divorce mediators,
we're not in the divorce business,
we're not family lawyers, we're mortgage brokers.
So what we wanna make sure is that we give you
the best chance to succeed.
So it's important to make sure that you and your partner
are on the same page
when it comes to variable versus fixed.
And not the same page from the perspective of yes,
I convinced him or her that they should take a variable,
so now they're on the same page as me,
it's like how do they really feel about it?
Would it really create stress if interest rates go up?
And if that's the case,
probably best to avoid variable rate mortgages.
Now let's say you are all about the numbers
and what's gonna save you the most money,
then let's talk about variable rate strategy
and what to look for in interest rates in order to determine
whether you should be getting a variable or not.
And one thing to keep in mind
is when we talk about variable rate strategy,
we're not just talking about variable rates
but we're talking about short-term mortgages as well.
So as part of a variable rate strategy,
we'll look at the variable rate
and we'll also look at the one year
and the two year mortgages.
And the reason for that is because essentially
a one and two year mortgage is a variable rate strategy
because we know that the payment
and the rate's going to adjust in a year or two.
So we look at those with the same eyes
that we would look at a variable rate
and what we typically do is we choose the mortgage
that has the lowest rate at the time
that we're getting the mortgage.
So up until this last couple of months,
five-year fixed were actually the lowest rate on the market,
they were lower priced than variable rate mortgages
and they were lower priced
than three and two and one-year mortgages.
So most of our clients were choosing five-year fixed
even if the variable rate strategy
was the right strategy for them.
Now that being said,
we didn't know that this pandemic was gonna happen,
we didn't know that rates were gonna go through the floor,
and therefore we had some people that picked five-year fixed
that were at a higher rate
than what the variable would have eventually ended up at,
but who would have been able to make that prediction?
So all we can do is deal with current information
when we're choosing a variable rate strategy
and the way we do that is by choosing the mortgage
that's the cheapest at the time that we get the mortgage.
And also, think of it this way,
it's also the cheapest when the mortgage is the biggest
'cause when we're getting a mortgage,
that's the largest our mortgage is ever going to be
and as we make payments,
the amount of principal is going to get paid down
and the mortgage is going to get smaller
and smaller and smaller.
So that's why we always believe
in taking a lower rate of variable rate strategy
when the mortgage is the biggest
is because that's when it's going to save us the most money.
So let's look at a real world scenario.
Now keep in mind, with this whole coronavirus thing,
interest rates are changing daily,
in fact, we've never seen them change faster.
So we have to be cognizant of the fact
that as I film this on May 4th,
on May 5th the rates may be completely different
and they may be completely different again on the 10th,
or the 15th, or the 20th.
So just use this information as an example
and use it as a criteria for looking at interest rates
when you do go to get your variable rate mortgage.
And if we look at today, May 4th 2020,
right now prime rate is at 2.45%.
And the best discount in the industry right now
is about a quarter point off of prime, so prime minus .25.
So therefore we can get a variable rate at 2.2%.
Fixed rates on the other hand are at 2.59%
for the comparable product
to what this 2.2 variable would be.
So there's a .39% difference.
So what that tells us is that the variable strategy
may make sense.
Now here's the thing.
Where's the threshold?
Where does it really make sense
to take a variable over a fixed?
Because what the data tells us
is that if the interest rates are the same,
we'll probably benefit from variable rate strategy,
but do we really wanna take that risk
when there's no room for interest rates
to go significantly lower?
So what we like to look at is that difference
and where we feel comfortable
getting a variable rate mortgage.
And where we feel comfortable is if the interest rate
is a quarter point to a half a point lower
than what the comparable fixed rate is.
Now in this scenario,
interest rates are about .39% apart,
so yes, it starts to make sense for us
to look at variable rate mortgages,
and that's exactly what we have
is we have a five-year variable mortgage
on our rental property,
we have it on our personal residence,
and we're keeping those mortgages
because they're significantly lower,
at least lower enough for our risk tolerance
than what the comparable five-year fixed is.
Now, once we've decided if the difference
between variable and fixed is enough for our comfort level,
then we need to go about choosing
the right variable rate mortgage and that's important here
because what you need to consider is three things.
You need to consider how the lender that you're choosing
does their lock-in rates,
you need to consider what their lock-in rates will be,
and you also need to consider whether or not
you can move the mortgage later on down the road
if that lender three or four years down the road
is no longer competitive
in their variable rate lock-in rates.
Because what you don't get to do
is you don't get to say okay I'm paying 2.2% right now,
I'm on a variable, I wanna lock in
and I'm going to lock in at 2.2.
It's not how it works.
What you have to do is you have to pick
a comparable fixed-rate mortgage that is greater in length
than the amount of time you have remaining on your mortgage.
So if you have three years left,
you have to pick a three-year fixed or longer to lock into.
And if the fixed rate mortgages
aren't competitive at the lender that you've chosen,
then you could end up having to lock in at a higher rate.
So you know picking the lender
that has the best lock-in rates is pretty important
and right now the two biggest lenders in the industry,
two biggest non-bank lenders are about half a point apart
on what their lock-in rates are.
So if you chose one over the other,
you could end up paying substantially more
when you're going to lock in your mortgage down the road.
And the second thing you need to consider
is whether or not you can even move
because there's a product out there
that has what's called a bona-fide sale clause
or a no-refinance clause,
and almost every lender has some version
of this type of mortgage.
And the problem with it is if you take a variable
and discounts go down,
so let's say they go from prime minus .25
to prime minus .95 again,
and you've got a no-refinance or a bona-fide sale clause,
then you can't switch into a lower variable rate mortgage.
And also, you can't switch to a different lender
and get a better lock-in rate on a fixed-rate term
if you've got those clauses,
so it's important not to have them.
Bona-fide sale clause, no-refinance clauses,
invariable rate mortgages right now are a big no-no,
you don't want to do it.
And then the third thing you want to make sure that you have
is a fair penalty
because some of the variable rate products out there
have what's called flat fee penalties.
So maybe it's 1% or 2% or 3%, or maybe it's at a scale.
So in the first year, it's a 5% penalty,
in the second year it's a 4%,
in the third year it's a 3%,
in the fourth year it's a two
and then the fifth year it's a 1% penalty.
Those products, we wanna make sure
that we don't have those either
because again, if your penalty is high
and you can't switch to a different lender,
if you don't have the option,
then you end up being put in a situation
where the lender can basically say to you,
okay, you want to lock in, you're paying this rate
and it's maybe substantially higher than market.
So you know making sure that your mortgage
is not only movable
but that it has a three-month interest penalty
and no restocking fees
'cause that's a huge thing in the industry right now
is 900 to $1,000 restocking fees,
and also making sure that the three-month interest penalty
is actually at what you're paying in interest, not a prime,
because what we're seeing right now
is we're seeing some lenders
that have three-month interest penalties
that are at 2.45% instead of being at 2.2%.
So you know making sure that we're paying attention
that we know exactly what goes in that mortgage
is really important.
Now here's the thing, in that 30-page document you get
when you sit down at the lawyers,
there's all these terms, all these conditions,
and the chances of a consumer picking out
the terms and conditions that are really important
when choosing a variable rate strategy
or even a fixed strategy for that matter are pretty small
unless they're a lawyer
and they're reading through the documents
and they're familiar with mortgage documents,
we've seen lawyers that aren't familiar
with mortgage documents
get confused with financial terms before,
then there's a pretty high risk that you're gonna get stuck
with something that is a surprise.
So having a mortgage broker that takes honesty,
transparency and accountability seriously
is really, really important,
especially when you're choosing a five-year fixed mortgage
and by the way, don't think that your banker,
the person who is employed by the bank,
whose paycheck comes from the bank,
has any obligation to you to tell you
if the mortgage that you're choosing
has a bona-fide sale clause or a higher penalty,
their job is to get you to sign on the dotted line
and sell the benefits and the features,
but not necessarily the restrictions of their mortgages.
So really important to make sure
that you've got a flexible mortgage and again,
that variable rate strategy comes down to two things:
is the risk tolerance acceptable to you,
and is the rate that you're getting at the time
the lowest possible rate you can get
if you're choosing that variable rate strategy?
And that's really it.
And all we do is we pick variable rate mortgages,
we have them with a big bank,
we understand that our variable rate mortgages
that we have with the big bank
are probably going to have high lock-in rates
and we know that when we go to lock them in,
we're probably gonna shop those rates around
and go to other lenders if we decide to lock them in.
Now I'm an economist, I know the math, I know the data,
the chances of us locking into a five-year fixed term
are pretty slim.
We've been in one-year fixed before,
we've been in two-year fixed before,
in fact, the mortgage that we most recently renewed
in August of last year wasn't a two-year fixed mortgage
and that was because that two and a half years ago
when we went to get that mortgage,
the two-year fixed rate was significantly lower
than what the five-year variable was.
So, you know we practice what we preach on this,
we are variable rate fans,
but only when the risk tolerance
is something that we're willing to accept
and when we know that we're getting a good enough deal
off of what the fixed rate would be,
then it's probably gonna make sense long-term
for us to be in that variable.
So that's how to choose a variable rate in 2020.
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Cheers, we'll see you again soon, thank you so much.