The debate over fixed or variable rates never ends. But there are now two things that are far less debatable:
1) The Bank of Canada is telling us that prime rate has likely hit bottom, and
2) “Safer” 5-year fixed rates are now as low as “riskier” variable rates.
(Safer, particularly if you choose a fair penalty lender.)
Given the above, if you’re getting a new mortgage you best have a bloody good reason to float your rate in this stage (the trough stage) of the business cycle.
One good reason that many cite is the historical outperformance of variable rates. Those data seem compelling. But what most don’t acknowledge is that said research depends partly on outdated assumptions.
Fixed rates actually win quite a bit…in the right sort of market.
If you run a general back-test to 1970 (as far back as good 5-year fixed data goes), for example, the results are notable.
If you assume, for instance, that:
A) 5-year posted rates sufficiently reflect the direction of fixed rates over time,
B) prime rate sufficiently reflects the direction of floating rates over time, and
C) borrowers in the past received the same discount as people get today
…then you’d find that 55% of the time variable rates averaged more than a 5-year fixed rate over a 60-month period.¹
Of course, borrowers never used to get the discounts they’re getting today, but it’s overall rate direction (i.e., the amplitude of rate peaks and valleys) that matters most to this sort of analysis.
Even if we adjusted for more historically relevant discounts (like those used by Canada’s father of modern mortgage research, York University professor Moshe Milevsky²) fixed rates would still outperform about one-quarter of the time.
One-quarter may not sound like a lot, until you realize that the one-quarter occurred disproportionately after economic slowdowns when fixed-variable spreads were tight…like today.
That’s why conservative borrowers can’t be faulted for locking in until 2025, assuming again that they choose a fair-penalty lender. There’s always that outside chance the Bank of Canada and/or bond market go negative on rates. In that case, fixing for 5-years might cost you.
But, with rates this low, any such cost won’t be enough to lose sleep over.
² Milevsky used up to 150 bps off 5-year posted and 75 bps off prime in his study, published in 2008.
Parting Note: The back-of-napkin math above isn’t intended to rival the rigour of Milevsky’s study. For one thing, a simple average of variable rates over 60 months doesn’t return a precise calculation of interest expense. But it’s close enough to the ballpark that one can see the infielders.