Variable and multi-term fixed= bye bye future negotiating power

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Whether it is nobler in the mind to suffer the swings and harrows of off-side variables, or to simply go fixed:  that is the question. Ok, Shakespeare said it better.

But, the question of going variable or fixed rate will always be a discussion topic, whenever the Bank of Canada increases their over-night lending rate to Banks.  I was asked by CBC Radio Calgary on June 1, "what should a consumer consider when trying to decide between the options of taking a variable or a fixed rate mortgage?

There are two significant issues:  your head and your heart.

Your head will tell you that fixed term rates have already increased ahead of the increase of the Prime Lending Rate.  A renewal or a new mortgage five year rate, discounted, is in the 4.50 range. Bank Prime's have moved from 2.25% to 2.50% and may have a .50% discount, making the current consumer rate 2.00%* 

(*Disclaimers galore! subject to consumer income, equity, credit, type and purpose of property, time of advance, and if Uranus aligns with Mars at 11.45 pm on Thursday, other conditions may apply, subject to change)  You have seen the ads.

So, with this example, there is a 2.50% difference in rate between the variable and fixed.  Many will take the attitude that on average over the next five years, variable will not go over 2.50% to therefore be more expensive over time compared to a five year fixed.

Your heart may tell you that you do not like your payments or your costs to be "unknown".   Just give me a payment that will be consistent with my budget for the next five years, and I will be a happy camper.  I will be able to sleep at night.

So, you will do what is right for you.

Now, some lenders are offering a hybrid mortgage.   You can take part of your mortgage as variable and part as fixed.

Keep in mind, that if you chose to change the variable to fixed because future conditions appears that rates are going to have a sustained upwards spike up....your variable and your fixed are subject to a penalty if you don't like what the lender offers you for the change of rates from variable to fixed. 

You have no negotiating power on your decision to change your variable because of the penalties.

This is especially true when you mix a variety of terms.

For example, say you take a part of your mortgage as variable, a part with a one year fixed term, another part with a three year fixed term, and the last part a five year fixed.

The strategy is similar to a financial planner's recommendation to "ladder" fixed rate investments into various terms.  The theory is to smooth out income for those depending on interest income as a major part of their total income.

Part of the money remains available at a moments notice at a low rate, just like a variable.  Part is in a one year term, part in three, part in five.   When the one year term is due, income (rate) maybe up or down, but most of the money is income protected with the remaining money in fixed terms.  This way, unlike having all the money come due for reinvestment at one time....when rates are very low, income is basically maintained.   If rates happen to be up substantially, income will not increase greatly if only a portion can be reinvested, but it will still go up somewhat.   It averages out.

BUT, this is where the financial planner's strategy for investment of term deposits differs significantly from using the same strategy for mortgages.

The investment term deposit is a separate financial instrument from the other investments.  When an investment term deposit comes due for reinvestment, the other term deposits stay "as is".   That means the investor is able to negotiate for the best rate on the term deposit that has come due.  If the current financial institution does not offer a good rate, the investor can move his cash to an institution willing to negotiate a better rate.  The other term deposits are not effected by moving the maturing term deposit cash to another place.

A mortgage is a single financial document, regardless if within the mortgage you can have a variable and a number of different terms.  When it is time to renew a portion of the mortgage, the rest of the mortgage is subject to penalty if you try to move the mortgage to a lender willing to offer better rates for the portion that has come due.   If you continue to "ladder" your terms, remember that a three year put into another three year will be an additional one year remaining when your five year variable and five year fixed rate come due.   If you find a better rate for the bulk of your money, the lender still gets to keep a piece of your "savings" because a penalty will apply for the amount owing with one year remaining on the term.

Moral fo the story:  half way measures to protect yourself could dilute your ability to fend for yourself in the future.