In Part 1 of the series, I discussed the reasons for mortgage rates movement and made a prediction that the interest rates will start to increase slightly during 2010. This of course leads to the question, is it better to go with a variable interest rate or a fixed rate?

Real-estate is mostly purchased for long-term, mortgages typically last 25 years and therefore it’s safe to assume that this is a long-term loan.

A study completed by Moshe Arye Milevsky of interest rates from 1950 to 2000 concluded that home owners are better off, on average, opting for a short-term variable interest rate compared to a long-term fixed rate. On average, a consumer with a $100,000 mortgage and amortization period of 15 years would pay $22,000 more with a 5-year fixed rate than an individual with a 1-year fixed rate.

CanEquity also concluded that variable rate mortgages have been a better option for consumers over the past 10 years. (http://www.canequity.com/mortgage_rate_history.stm)

Based on these studies, it’s clear that the variable rate mortgages are advantageous, however, they may not necessarily be right for you.

Let me give you an example:
You are generally a risk-adverse individual; you own several rental properties that are self-sustaining via rents collected; you do not have any additional cash that you want to be putting into those properties.

If you own a rental property in Kitchener-Waterloo-Cambridge for example with a variable rate of 1.95% and a $200,000 mortgage on a 25-year amortization period, your current monthly mortgage payment would be $842.85.

If you were to obtain a fixed 5-year mortgage today, your interest rate would go up to about 4%, and would result in a monthly mortgage payment of $1,055.67 – this payment would be locked for 5 years guaranteed not to be any higher or any lower.

If your current rents can still generate positive cash flow with a 5-year fixed rate, then you might want to pay additional $200/month to sleep comfortably at night knowing that you will not have to put any personal financing into the property for the next 5 years, especially knowing that the interest rates are expected to increase.

Personally, I’m more of a risk-taker and I don’t expect the interest rates to be higher than 4% on average over the next 5 years, therefore I would opt for a variable rate mortgage. If I were more risk adverse I could bank the difference today and dip into that pool if my variable rate rose above the 5 year fixed rate. In addition, seeing statistical studies performed by reputable sources reinforces my stance on this issue. When it comes to variable versus fixed, there is a premium for the certainty of a fixed rate, and in the long run variable has been proven to win.

This entry was posted on Monday, February 8th, 2010 and is filed under Real Estate Investment Tips. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.