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June 18th, 2019 
Ronna Campoli
Sales Representative

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Variable mortgages (almost) always win

Whether they're taking on new mortgages or renewing ones they've held for

years. homeowners end up asking themselves the same question: Should

they lock intheir mortgage or should they let itfloat with a variable rate. Here,

Toronto.based wealth manager Scott Tomenson makes the case for variable.


Q: My fiance and I have just bought our first home and we are going in circles about

what is the best mortgage for us before we close. We currently have a locked-in fixed

rate with a bank of 3.98%, which we prefer to the uncertainty of taking a variable mortgage.

But would we be better off with a variable-rate mortgage, especially if we saved

money during periods when rate are low and use that to make payments on principal?

Will that offset costs when our payments are higher than our current fixed rate?

Getting Dizzy, Ontario

A: Historically, as far as interest rates are concerned, it is better to float your mortgage

interest rate (i.e., choose a variable rate mortgage). This is a result of the "yield curve."

The "normal" yield curve is positively sloped, with interest rates lower for short-term

maturities (one to two years) and higher for longer-term maturities (five to 30 years).

When the economy strengthens, the Bank of Canada will raise short-term interest rates

(they only have control over short-term rates) and the base for variable-rate mortgages

(usually the prime rate) is moved higher. This action signals a period of "tightening" of

monetary policy to cool the economy and reduces inflationary pressures.

The vehicles that determine longer-term interest rates - bonds - tend to move

according to inflationary expectations: If bond investors anticipate inflation (because

of economic growth), they demand higher returns (interest rates) as protection from

inflation. When the Bank of Canada is perceived as "fighting" inflation by raising shortterm

interest rates, long-term rates have a tendency, in most cases, to remain stable or

improve, because long-term bond investors are content that inflation will not grow.

In essence, while short-term interest rates may go up, they do so only until the Bank

of Canada has slowed the economy enough to curb anticipated inflation. Then, as economic

growth slows, the bank starts to lower them. The yield curve will flatten (with

higher short-term interest rates) for a time, but when the economy slows, short~term

rates will go back down and the yield curve returns to its "normal" positive slope.

Over this time, variable-rate mortgages will move up to being approximately equal

to locked-in five- or to-year rates, but that's followed by a period when they return to

lower levels. More often than not, over this time, it is less costly to have held the variable

rate debt. Exceptions to this situation would be times of hyper-inflation (like in the

1980s) when short-term interest rates went to extreme levels.

If you had a variable mortgage at prime minus over the past few years, as I did, it's

been a great ride. I kept my payments level and the low ihterest rates allowed to me to

payoff massive amounts of principal. True, the economy is strengthening and shortterm

rates will go up a bit over the

next couple of years, but I don't think

it will be dramatic. The case for variable-

rate mortgages remains strong.

APRIL 2010 FPM41

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