The security of fixed-rate or the cost savings of adjustable-rate — which mortgage is better for you?

General Vivian Pritchard 14 Dec

All mortgages are not created equal. In addition to principal amount, interest rate, amortization period, prepayment options and whether the mortgage is “open” or “closed,” the remaining major characteristic is whether the interest rate is fixed or adjustable.

Both fixed and adjustable-rate mortgages have consistent monthly payments that blend interest costs and principal repayment. They differ in how the payment is applied between interest and principal. 

On a fixed-rate mortgage, the proportion of the payment applied to interest and principal changes over time according to a standard schedule. In the early years of a mortgage, more of each payment is applied to interest, and less to the principal. In later years, less is applied to interest and more to reducing the principal.

With a adjustable-rate mortgage, the amounts applied to interest and principal vary [from the standard schedule] as the interest rate moves up or down. As rates increase, more of the payment is applied to interest and less goes to principal. When interest rates go down, less is applied to interest costs and more to principal.

Which is right for you depends on your risk tolerance. If an increase of 0.25 per cent in the interest rate would concern you, or substantially affect your budget, then a fixed-rate mortgage may be a better choice. However, today, the security of a fixed rate comes at a slightly higher price.

Research suggests adjustable-rate mortgages benefit consumers. From 1950 – 2000, Milevsky found that homeowners with a $100,000 mortgage (15 year amortization) would have saved approximately $22,000 in interest costs by borrowing at the prime rate instead of the five-year rate. Further, he found that choosing the adjustable rate benefited the homeowner during 88 per cent of the period studied.

To find out more about fixed versus adjustable mortgages or to see what solution best suits your needs, contact me today!