Hamlet once asked, “To be or not to be?” That is no longer today’s question. Nowadays, we are plagued by a different query. It is better to go with a fixed rate or a variable rate mortgage? We need to know how beneficial it would be to lock into a longer-term fixed mortgage rate or stay in a variable rate. Short term rates are at a tremendous low and the pressure is on for rates to build in the coming years. So, what’ll it be? Fixed or variable; which is the better option?

Generally borrowers save money by staying in variable products and weathering the storm of fluctuating rates. Since 1975, approximately 80% of the time, the cost effective route for borrowers was to stay variable. The spread between 5 year fixed mortgage rates and variable rates has been widening further in recent years. It is now close to an all time high.

There are four important points to consider before we jump to any conclusions in thinking the variable rate is the way to go.

  • We have been locked in a long-term declining rate environment since the early 1980’s.
  • The Bank of Canada’s overnight rate is now as low as it can possibly be. There is no further downside for variable rates.
  • Posted rates do not tell the whole story. The actual rates that borrowers negotiate have fallen much closer to fixed and floating in recent years than suggested by headline figures.
  • During the late 1970’s and the late 1980’s, fixed rates were advantageous (ahead of a period of rising interest rates, as is the case now).

A conservative fixed rate mortgage can alleviate a number of risks. Inflation hasn’t been a problem in Canada since the Bank of Canada embraced inflation targeting, averaging 2% since 1991. An outside risk of an inflation flare-up lurks as global central banks keep their focus on policy. These efforts will play a huge part in sparking inflation especially if the global economic recovery is stronger than projected. Those potential scenarios could force the Bank of Canada to assertively raise interest rates. This will drive variable mortgage rates higher but leave the fixed rate without a scratch. Fixed rates are attractive in the current environment because short-term rates are at their lowest ensuring that rates will only skyrocket from here as the economy convalesces. As in the 1970’s and 1980’s, while the economy is emerging from recession, this turns out to be one of the rare times where a fixed rate is a superior choice.

Contrary to its counterpart, a variable rate mortgage has been consistently less costly over time. The current outlook for inflation remains benign with important excess capacity in Canada. Ultimately, this will keep the price pressures at bay well into 2010. As the Canadian dollar continues to soar, it puts much downward pressure on prices and reduces the near-term need for the Bank of Canada to raise rates. Low and steady inflation, taken with a brittle global economic recovery, points to the Bank keeping its pledge to hold rates steady through June 2010. This is of course, conditional on the inflation outlook. Fixed rates could potentially fall if the economy performs worse than anticipated. However, one will always have the option to lock into a fixed rate at a lower date.

In the end, the verdict depends on the individual but, bear in mind, the devastation of the economy is far graver than we’re giving it credit for. Due to the slow economic output, the economy must significantly recover from the recession before the Bank of Canada increases interest rates. We recommend a variable rate mortgage, a sound choice in today’s unstable economic climate because in the long run, you will save money.