Types of Mortgages
Fixed, Floating, & LOC Information You Need
To Make an Informed Decision…..
There is no right or wrong answer when it comes to which is better, Fixed, Floating or Line of Credit. The fact is they all have pros and cons, and no one knows for sure what the mortgage rates will be in the future, and how the economy will affect the rates over time. The main decision making factor will likely depend on you, your personality, and your personal and financial situation and goals. At Synergy mortgage our commitment is to assist you in your journey to becoming well informed and fully prepared so that you have the knowledge to make smart decisions that are right for you and your family. Here is a quick overview and reference designed to highlight a few of the main considerations regarding suitably on each mortgage type.
Fixed Rate Mortgage
With a fixed rate mortgage the interest rate will not fluctuate and the monthly payments which include principal and interest and will remain the same for the duration of the term regardless if the Bank changes their rates. Fixed rate mortgages are easy to understand and provide rate stability. Borrowers are able to create a predictable budget each month, making it less risky than a floating rate mortgage. Most lenders offer fixed terms of one to ten years, however, in the past years the most popular has been the 5 year term. Today’s fixed rates are unusually low, and expected to stay that way for some time.
- Rate-sensitive borrowers
- First-time buyers
- People who intend to keep the mortgage for the length of the term
- People who worry and don’t want the uncertainty of rate fluctuations
- Growing Families
- People on tight budgets
- People who like predictable expenses
Floating / Variable Rate Mortgage
A floating rate mortgage has a rate that will fluctuate with the bank’s ‘prime rate’ during the term of the mortgage. The payments include principle and interest. In year 2000 the Bank of Canada introduced a system of eight fixed dates each calendar year on which it announces whether or not it will change the ‘key interest rate’. In turn this rate is used by the major financial institutions when setting their ‘prime rate’. The fluctuations may be up or down depending on many economic factors. With a floating mortgage the lender will generally offer the borrower a specified percentage below prime rate. The discount will not change however, prime rate will likely change either up or down several times during the term. The term is usually closed for 3 or 5 years, but some lenders offer fully open floating mortgages that may be paid off at any time without penalty. Floating rate mortgages have been very popular in recent years as prime rate has remained very low compared to the 5 year fixed rate options however, this gap has narrowed considerably and both options are similar. In 2013 many borrowers have opted to lock in to the fixed rate options since they reached levels slightly lower than prime.
It is a little more difficult to qualify for a floating rate mortgage compared to a fixed rate mortgage. In some cases a borrower may not qualify for a floating rate product but would qualify for the fixed rate product. The lender may cut back the size of loan if you choose a floating rate product over a fixed rate product, to protect payment shock from rate increases. Recently, the discount below prime rate has shrunk from Prime – .90% to Prime – .35% or less. Based on the economic predictions of continued low rates, many borrowers are still confident going with a floating rate even though they can no longer get the deep discount.
- People with moderate risk tolerance
- Sophisticated Borrowers
- People who are not on a tight budget
- People who qualify for a larger mortgage than they need
- High net worth borrowers
- People who want a more predictable penalty if they pay the mortgage off in full prior to completion.
- People who want to float at lower than current fixed rates, and take advantage of current teaser rates.
- People who want to lock into fixed rate at a later date.
- People who plan on paying off the mortgage in the short term by choosing an ‘Open’ variable.
Line of Credit (LOC)
Line of Credit (LOC) also known as Home Equity Line of Credit (HELOC) is a special type of credit line, secured by the equity in the borrower’s home. The lender sets a maximum amount that the borrower can draw down, and the entire amount of the loan is not advanced in contrast with regular loans. On a LOC you pay ‘interest only’ on what you actually draw down. New mortgage rules, introduced in 2012 now cap the maximum line of credit at 65% of the lending value. It is re-advanceable so you may draw down the funds and then pay them back and then draw them down again. The interest rate fluctuates with prime rate and is usually set at Prime rate plus a specified percentage.
- Sophisticated borrowers with moderate to high risk tolerance
- People who are comfortable with rate fluctuations
- People with strong stable cash flow that don’t mind paying slightly higher rate in exchange for maximum flexibility
- High equity homeowners
- People who want flexibility to make unlimited lump sum payments or pay off the mortgage at any time without penalty
- Small business entrepreneurs
- People who want to maintain a high cash flow
- People who want to cover home purchase and future financial needs
- People who want a fully open product and want easy access to funds
- ***NEW CHANGES***Maximum 65% loan to value on line of credit portion.
A very popular option today offered by select lenders only is the combination mortgage which combines fixed mortgage, floating mortgage and /or line of credit into one mortgage offering exceptional flexibility and diversity. Some lenders also allow a VISA card, and overdraft protection into this one single comprehensive borrowing program. This mortgage allows you to have a portion of your mortgage fixed for your own security and floating to take advantage of low rates, and line of credit to allow future advances on your equity without rewriting the whole mortgage so you will not incur additional legal fees. You may continually draw out equity, for automobile purchases, investments, etc. and keep a portion fixed and stable.
Most fixed and floating products are arranged as closed mortgages. A closed mortgage includes terms that state that it cannot be paid out until its maturity date. In most cases the lender agrees that the mortgage may be paid out early, with a 3 month interest penalty or Interest Rate Differential (IRD) whichever is greater. Warning: IRD penalties are calculated slightly differently by each lender and can be substantial when market mortgage rates are declining.
This type of mortgage may be paid back without notice or penalty. An open mortgage is generally more expensive than a closed mortgage, which would have a penalty to pay off early. In the event a borrower is planning on paying off their mortgage in the short term, it is recommended to have an open mortgage.