Fixed or Variable?

2009-11-19 | 09:59:17

It’s the question Canadian home owners are obsessing over: Should I stay fixed or go variable? Historically, borrowers have saved money by choosing a variable mortgage product, according to a report from BMO Capital Markets. But a risk of a pronounced upswing in interest rates, which can only move higher as the economic recovery takes hold, means fixed rates could actually prove to be the cheaper alternative at this particular point in time.

 “In fact, mortgage pricing is relatively efficient and the fixed rate is usually a good approximation of expectations of the variable rate,” BMO Economists Douglas Porter and Benjamin Reitzes said in the report. “However, our core view is that the most likely economic and interest rate outlook will ultimately again slightly favour the variable rate option – and that’s particularly the case given BMO’s current rate of 2.25% – but it’s a much closer call than usual.”

 Since 1975, borrowers who opted to go variable were the hands-down financial winners 82% of the time. In addition, the BMO economists noted that the spread between five-year fixed mortgage rates and variable rates has been widening further in recent years, and is now close to an all-time high.

 Fixed rates were advantageous through the late 1970s and briefly in the late 1980s, and in both cases ahead of a period of rising interest rates, as is the case now, BMO said.

 And given that the Bank of Canada’s overnight rate is as low as it can go, there is no further downside for variable rates and any future surprises can only be to the upside, the report said. An outside risk of an inflation flare-up, especially if the global economic recovery is stronger than expected, “could force the Bank of Canada to raise interest rates aggressively, driving variable mortgage rates higher, but leaving fixed rate choosers unscathed.”

 On the other hand, the current outlook for inflation remains benign and the rising Canadian dollar is pressuring prices.