Fixed or Variable Mortgages For Landlords

August 25th, 2011 · 4 Comments · Mortgages

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Creative Commons License photo credit: Diana Parkhouse

Since I was a mortgage broker in a past life, this is actually a topic that I know a little bit about. You should regard anything I’ve wrote about in the past as crap wonderful prose. Of course, you already have.

Fixed vs Variable

There have been all sorts of studies about fixed vs. variable mortgages in Canada. And, for the most part, you’ll save money if you go variable. The reason for this is as follows. There’s a spread between fixed and variable rates, with a fixed 5 year rate usually 1-1.5% above what a comparable variable rate is.

Is Security Worth It?

Since interest rates are usually pretty stable, this means the fixed mortgage holder is paying a premium for the safety of knowing what their rate will be throughout the 5 year term. Most people will gladly pay that premium. It’s a form of insurance, and the difference in the payment is the premium. Since approximately 70% of Canadians go with a fixed rate, the majority of us are willing to pay for the certainty of a fixed rate. In the past, I’ve done the same. When I took out mortgages to buy my rental properties, each of them were fixed. Why? Well, there’s really only one reason: I didn’t even know variable rate mortgages existed. Lame, I know.

What Should Landlords Do?

As is the answer to any good question, it depends on the situation. As the stock market melts down, investors are fleeing the panic to the safety of bonds. Because of that, fixed rates have come down considerably over the past few weeks. I can get a five year fixed mortgage in Alberta for 3.09%. People in Ontario can’t quite do that well, but they should be able to find mortgage money at less than 3.5%. Fixed rates are incredibly cheap right now.

The Global Economy

Look at the general economic picture. There’s a risk of a double dip recession. Europe’s financial system is a mess. The American debt still looms large. All of these aren’t good for the underlying economy. And a weak economy will keep rates low, at least in the near term. We’re looking at months of good news before the Bank of Canada even considers raising rates. All this means that, at least for the short term, real estate investors should be just fine holding a variable mortgage. Right now, if I was buying real estate, I’d have no problem taking on a variable mortgage.

Why You Should Choose Fixed Anyway

After that whole section that seemed like I recommend a variable mortgage, I think fixed is actually the best bet for most landlords. We all know how tough this business can be. Tenants have a habit of not paying rent, breaking stuff, and generally being annoying. We have renovations to worry about and taxes to pay. Insurance isn’t cheap, neither is a new roof. All these costs keep going up. And as we all know, these increased costs eat into our profits. Owning property is a tough business, with costs that can be unpredictable. While every landlord should have cash set aside for the next needed repair, it’s hard to get that cash.

Go for Security In An Uncertain Business

So why expose yourself to interest rate risk on top of all this? Give yourself cost certainty. You don’t know how much you’re going to have to pay out in repairs next year. You don’t even know how much rent you’ll collect, since that’s all dependent on your tenant. By taking out a fixed rate mortgage, you at least know how much interest is going to cost. There are a lot of landlords who employ more leverage than I’d be comfortable with. As we all know, as the amount you borrow increases, so does the risk associated with the loan.

Slim Cash Flow

Many landlords only have a couple hundred bucks a month of cash flow once they pay all their expenses. These owners are especially vulnerable to any increases in interest rates. If cash flow is tight, you’re crazy to risk an interest rate move against you. If you’re one those landlords who only borrows a bit, then by all means, choose a variable rate. You can afford to take the risk. Most landlords, however, just shouldn’t be taking the risk.

Nelson Smith has his own blog. It’s Financial Uproar. Plus, he’s handsome. He really is the total package ladies.


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