TORONTO — Variable-rate mortgages are tempting a growing number of Canadians with alluringly low interest rates, some of them lower than three per cent and promising substantial savings over fixed-rate mortgages.

And while choosing a deal that floats with the bank prime rate might seem like rolling the dice on one’s home, variable-rate mortgages are sexy because they currently undercut their fixed-rate cousins by two to three percentage points.

But, as with any deal that seems too good to be true, there’s a catch.

The key element of variable-rate borrowing is the link to banks’ prime lending rates, with special discount offers of up to one percentage point. It also requires consumers to determine their own comfort level and it demands — above all — vigilance.

“Although I’m not sure I’d call it a gamble, it’s certainly speculative,” says Moshe Milevsky, finance specialist at York University‘s Schulich School of Business in Toronto. “You have to realize that taking the smaller number sometimes means that it may become bigger later.”

Variable-rate mortgage holders have to stay aware of current interest rates because they can spike up, though most analysts are predicting only modest-paced increases for the next year. A Bank of Canada survey released this month says its senior managers foresee slightly higher inflation — which makes it very likely the central bank will boost interest rates as early as September.

If the prime rate climbs two or three per cent, a variable-rate mortgage costs a lot more. But at this point, analysts feel interest rates will only creep up, probably not much more than one per cent over the next year.

Most banks and lenders offer consumers the option to lock in to a standard fixed-rate mortgage when they feel the prime is going up too much or too fast. Beware of extremely low-rate variable mortgages that don’t have a lock-in option — if interest rates skyrocket, you are tied to them with no way out until the mortgage term is up.

How to choose when it’s time to lock in is crucial to managing variable mortgages.

“There’s never a perfect time, but there’s a better time than others to make that decision,” says Colin Dreyer, president of the Canadian Institute of Mortgage Brokers and Lenders.

For example, if a person’s employment status changed, a bump in rates could signal it’s time to consider the stability of a fixed rate.

“To be on the safe side, they’ll lock in, rather than gamble on their rate and a possible change in employment at the same time.”

But just because rates are on the rise doesn’t mean it’s automatically time to lock in. If rates go up but are expected to fall again later, the savings will still be there over the long run.

“Those variations are always going to be there. You can’t predict rates,” says Dreyer.

Milevsky suggests setting monthly payments under a variable-rate mortgage at exactly what they would be had you taken out a fixed-rate mortgage (your bank manager or mortgage broker can do the calculations). That way, if you do have to lock in, you won’t feel any difference in your daily finances.

And he pays very close attention to the spread between variable- and fixed-rate quotes.

“If that spread gets very, very small — perhaps even negative — I might take a look and say ‘It’s not worth the risk any more,'” Milevsky says.

“The question to ask yourself is, ‘How high can the rate go before you actually start to feel the pain?'”

You should also know the difference between an open floating-rate mortgage and closed floating-rate borrowing. With an open mortgage, you can pay down any amount you want during the term. With a closed mortgage, there is a penalty for making payments over and above the set payment schedule.

About one-third of all Canadian residential mortgage holders are going with variable-rate mortgages tied to a prime rate currently around 3.75 per cent.

“I think people look at that and say, ‘I can buy more real estate because of that aspect of it,'” says Dreyer. “It’s the affordability factor.”

Paul Mims, vice-president of CIBC Mortgages Inc., says the popularity of variable-rate mortgages has seen an explosion in recent years because of low rates.

“If you’d asked five years ago, it would have been less than five per cent [of the mortgage market],” says Mims. “The CIBC portfolio was less than 10 per cent. And now we’re 50- per-cent variable.”

Mims believes that right now the variable is the way to go.

© The Vancouver Sun 2004