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When it Comes to Your Mortgage, Every Day Is Opposite Day

08/14/2013 12:30 EDT | Updated 10/14/2013 05:12 EDT

Have you noticed over the last few months that the banks have really been pushing variable (floating) rate mortgages? The banks are basing this on historical information, which in my opinion is irrelevant today.

It is true that, overall, interest rates have been on a downward trend over the last two decades. There have been a few increases (like 1995), but basically the rates have come down from about 12 per cent in 1990 to a low of 0.91 per cent in 2010 (these rates are based on the average yield of 6 month treasury bills).

But it wasn't too long ago that banks were recommending locked in mortgages because they told us rates could be going up. What happened, of course, is that interest rates came down as we've seen, and a lot of people were (and some still are) paying significantly higher interest.

If you locked in your mortgage for 5 years at any time between 1990 and 2012, you would have been paying more interest than a floating rate because the rates were moving down. It's not unusual to see a variable rate 0.5 per cent to 0.75 per cent lower than a 5 year fixed rate. On the surface it does look attractive, however, what happens when rates rise?

Today they're telling people to choose variable rate mortgages because the rates are so low (most banks will give you a variable rate below prime) over a fixed rate mortgage. Why do you think this is? Here's a hint -- it's not because it's in your best interest. With a variable rate mortgage you assume 100 per cent of the risk and the bank has a guaranteed profit margin.

Considering interest rates today, I don't think there's much chance for them to go down. The going rate right now for a 5 year fixed rate mortgage is about 3.39 per cent. The current variable rate is about 2.75 per cent.

If you have a $400,000 mortgage, the difference in interest between a fixed rate mortgage at 3.39 per cent and a floating rate mortgage at 2.75 per cent is about $213.33 per month. Although this is a fairly significant amount, a lot can happen in 5 years. If the rates go up 1 per cent over the next two years, your interest costs on a floating rate mortgage will go up 36.36 per cent. If rates go up 1.5 per cent, it will increase your interest costs by 54.55 per cent.

Confused by my math? If you start with a mortgage rate of 2.75 per cent and it increases to 3.75 per cent, that extra 1 oer cent is 36.36 per cent of the original 2.75 per cent. An extra 1.5 per cent is 54.55 per cent more than the original 2.75 per cent. So, even though the 2.75 per cent floating rate may look attractive today, it will probably not stay that low for the next five years.

I'm a great believer in certainty. If you know that your mortgage is locked in for the next 5 years and that you can handle the payments today then that would be my advice. If you're a gambler, then go ahead with a variable rate or, if you're a fence sitter, perhaps a combination of the two. Whatever you choose, do it sooner rather than later. It's only a matter of time before the interest rates start to rise.

And between you and me, banks usually increase their mortgage rates before the Bank of Canada raises the central bank rate, so pay attention!