One of the most challenging tasks when shopping for a home loan is to choose between a fixed rate loan or a floating rate loan. Is fixed rate always better than floating rate, or vice versa? To answer this question, you have to form your opinion about how rates will behave in the next two to three years while your loan is locked up, and how that impacts your overall cost. Below, we discuss a few possible scenarios that you should consider and how to take advantage of each type of loans in these situations.
Fixed rate is better in a rising interest rate environment
When the interest rate is rising, fixed-rate loans can give you up to 10 per cent of cost savings by locking in the current (low) interest rate. According to our analysis of 2000-2017 historical interest rates, you could save as much as $16,641 by choosing fixed rate if you took out a loan of $400,000 in 2005, when the market rates began to rise steeply. These estimates are based on interest rate of 0.50 per cent plus the benchmark 6-month SOR, a 3-year fixed-rate period. We also assumed that the rate continues to rise to 5.00 per cent until 2022, after which the rate stays constant.
The result consistently held true for all three time periods, as long as they represented a rising interest rate environment. For instance, you would've save about $10,169 in interest cost compared to floating rate if you took a fixed-rate mortgage starting 2014, because interest rates have been steadily rising during 2014-2017.