Worth the penalty to change to variable rate?

[Millions]

As Many probably know by now, I have a 2 bed condo in Killarney.

Currently I`m negative $300 on it so my tenants pay the interest, I pay the principal.

I`m considering switching to variable which would almos break it even for the time being.

Current details

bank: scotia
motgage balance: 238k
term: 5 years with 4.5 left. 33 year amm.
Rate: 4.19% fixed
payments : $1115

If I switch to variable

penalty they want to charge: $2000 (unless I can talk them down even more)

rate: prime - .4
5 year closed
new payments: $820 currently or so.

I spoke to a broker who told me even if prime goes to 6% over 5 years, I will still save with variable but I don`t quite understand this because if they w ent to 6% in a year as an example, I would lose forsure.

I don`t forsee that ofcourse but what is everyones opinions?

Worth paying the penalty if I need to in order to switch to prime or will it most likely balance out anyways. ?

 

[Demerara]

I think variable is a good option even with the penalty. You are talking about a $300 difference so it is only 6 months at the lower rate that will take care of the penalty amount based on the differential, and then you benefit from the lower variable over some unknown extended period.

As for:
"I spoke to a broker who told me even if prime goes to 6% over 5 years, I will still save with variable but I don`t quite understand this because if they went to 6% in a year as an example, I would lose forsure."

If prime did jump to 6% within a year, yes you would lose but I think he is suggesting even as rates ratchet up it will take a while to hit 6% and in the meantime during that slow drawn out increase in prime, you would pay less overall.

Of course the big unknown is whether rates increase significantly over the next 5 years. My bet is they will increase but not substantially (as in up to 6%).....but it is a guessing game.

 

[Nir]

Hi Matthew,
I would definitely pay $2,000 (you mentioned maybe less) to switch. pls remember it is both a personal and mathematical decision.
The reason I`d switch is you are expected to pay less. period. the reason many would not switch is because expected is just an "average" and the risk is higher with variable. In other words, with fixed you know exactly how much you will pay every month, with variable you don`t and you risk paying more than fixed.
personally, I give much higher weight to my "expected payment" than risk associated with it, therefore always prefer variable!
Regards,
Neil

 

[JoeRagona]

QUOTE (investmart @ Jun 2 2010, 11:03 PM) In other words, with fixed you know exactly how much you will pay every month, with variable you don`t and you risk paying more than fixed.
Neil

Remember you can also use a strategy that follows the `fixed` payment. Just pay the fixed rate (or a bit less) and you still know what your payments are. The upside is that you are paying more towards principal.

 

[Nir]

QUOTE (JoeRagona @ Jun 12 2010, 11:00 AM) Remember you can also use a strategy that follows the `fixed` payment. Just pay the fixed rate (or a bit less) and you still know what your payments are. The upside is that you are paying more towards principal.

you can follow the `fixed` payment only as long as variable interest is lower than initial fixed offered. the risk is still the same: if and when variable rate increases above initial fixed, your payments will have to be higher. that`s the risk, otherwise everyone would take variable.

 

[JoeRagona]

QUOTE (investmart @ Jun 14 2010, 12:00 AM) you can follow the `fixed` payment only as long as variable interest is lower than initial fixed offered. the risk is still the same: if and when variable rate increases above initial fixed, your payments will have to be higher. that`s the risk, otherwise everyone would take variable.

For the spread between variable and 5 yr fixed (I`m sorry - in my first post I failed to mention 5 yr fix) to close and put you in a position that your payments would have to increase, it would take a while. Of course, this is all depending on your tolerance, but IMO, I can`t see the banks raising the overnight rate that rapidly to catch the five year fixed any time soon. So, during the lull you can pay down quite a bit in principal.

 

[Millions]

QUOTE (JoeRagona @ Jun 14 2010, 07:59 AM) For the spread between variable and 5 yr fixed (I`m sorry - in my first post I failed to mention 5 yr fix) to close and put you in a position that your payments would have to increase, it would take a while. Of course, this is all depending on your tolerance, but IMO, I can`t see the banks raising the overnight rate that rapidly to catch the five year fixed any time soon. So, during the lull you can pay down quite a bit in principal.

true. Although at 4.19, there is only a 2% difference. I seem to have lost the link on what don predicts for interest rates. Does anyone know what the prediction is? Think variable will be at 4% in 2 years time? Or sooner? Think the banks will lower their margins to previous ones?

 

[jkcomm]

Hi Matthew,

P - 0.4 sounds too low! If you are paying for the penalty, you might as well get the most bang for your buck. P - 0.5 is now the norm for variable rate mortgages.

James

 

[MikeMcCrae]

Your break even at today`s rates is about 5 months. If prime does not go above 4.59 in the you will always be ahead. So you have to decide if you are willing to take the risk on rates climbing and when. No one has a definitive answer for you but in the past variable has always out performed fixed.

 

[JimWhitelaw]

Hi Mike, I`m interested to know how you calculated that. Can you "show your work" for us? I think that would be helpful to see how you`re evaluating the the break even point. thx