Before Choosing Fixed, Consider a Hybrid Mortgage

A reader writes: “My wife is conservative and wants fixed, but I think going variable makes more sense. What mortgage option should we choose?”

When clients can’t decide between choosing a fixed or a variable rate mortgage, I often raise a pretty strong alternative that offers the best of both: “Have you considered splitting the mortgage into one part fixed and one part variable?”

According to industry association Mortgage Professionals Canada, about 4 per cent of mortgages are classed as ‘hybrid’ or ‘combination’ mortgages that may consist of fixed and variable components, or may split the mortgage into various term lengths. The hybrid option I recommend consists of a 50/50 split between fixed and variable.

With Canadians fearing additional rate hikes in the coming months and years, the shift in favour of fixed over variable is on, according to MoneySense magazine, citing data gathered from a rates web site. More than half are now opting to lock into fixed rates.

Here are five points to ponder when considering the hybrid mortgage option:

1. You get the predictability of a fixed rate and the savings of a variable rate. However, some experts believe the spread needs to be at least two percentage points to see significant benefits.

2. While interest rates are notoriously difficult to forecast, a hybrid 50/50 split can leave you with more mortgage principal paid down relative to interest in three scenarios over the next three to five years:

• rates increase slightly
  
• rates stay put, or
  
• rates decline

3. If rates increase substantially during that period, there is good news and bad news. The good news is that 50 per cent of your mortgage is locked into a fixed rate. The bad news? The remaining 50 per cent is exposed to rate fluctuations. An all-fixed option is best if you don’t have the financial flexibility or risk tolerance to deal with that exposure.

4. You may lock in the variable rate at any point. However, you will likely pay a three month interest penalty to do so and will have to negotiate the fixed rate.

5. Keep it simple. Make sure that both fixed and variable segments have the same term length – say 5 years – which gives you full flexibility to switch lenders once both terms expire.

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Susan Williams is a Mortgage Development Manager with National Bank of Canada. Email: susan.williams@nbc.ca Twitter: @YMJourney