A friend of mine asked me if he should get a fixed rate or floating rate mortgage. When we purchased our house about four years ago, we opted for a five-year, fixed-rate mortgage and in the past four years, the variable, below-prime mortgage rate has never been above our fixed rate of 5.25%. The Bank of Canada is now holding interest rates steady and the consensus opinion is that the Bank will cut interest rates in 2007. In our case, we could have saved a bundle on interest costs if we had opted for the variable rate mortgage.
Prof. Moshe Milevsky, a Professor of Finance at York University has done extensive research on this topic and has published an easy-to-read paper titled Mortgage Financing: Floating Your Way to Prosperity. He analyzed interest rate data from 1950 to 2000 and found that Canadians would have been better off borrowing at the prime rate versus the 5-year rate 88.6% of the time.
Prof. Milevsky revisited his original article (Mortgage Financing: Should You Still Float? Four Answers) in 2004 when interest rates were at historical lows and offers this advice:
The decision of whether to go long (fixed) or short (floating) should depend on your tolerance for risk as well as your ability to withstand increases in mortgage payments. You can always expect a financial reward for going with the float, although the precise magnitude will ebb and flow depending on the economic environment.