Fixed Rate or Variable Rate ? See This Simulation, Get Clear Answer!

   

When interest rate is expected to be going up, the classic question of most mortgage holder is “should I fixed my rate or keep it variable”. And most answer they got will be the usual vague notion: “It depends”. Well, do not settle with that answer, because with simple simulation below you will have your answer yourself with your own number! (The good news is, don’t worry about the calculation as the software will take care it for you)

(If there is a mortgage product that allow you to fix  the interest rate for long period: 20 or even 30 years with very competitive fixed rate – go for it. Unfortunately not every country have that great product, they have to juggle between lower variable rate or higher fixed rate with fixed short term – before revert back to variable rate
Note= variable rate = flexible rate = adjustable rate)

Let The Number Talks

For our discussion let’s say that we have $350,000 mortgage and we are considering between a Fixed Rate mortgage (7.59% interest, $8 per month account fee) and a Variable Rate mortgage (5.91% interest with $300 per year account fee). And the bank charge $300 to switch between the fixed and variable product. We also know that usually reserved bank increase by 0.25%. (All number are real as per December 2009). This can be summarized in table below:

Just by simple calculation, the difference between the fixed rate and variable rate can be seen below:

Yes, if the rate stay where it is now for a year, if you stay in variable rate, it will save you just under $6000 for a year -or- around $490 a month. And if the rate is going down, you can save even more. But, of course no body knows for sure whether the rate will go up or down next month. The movement of interest rate is simply impossible to predict accurately. Furthermore, the bank can just raise the interest without even waiting for the reserve bank.

So, for our analysis, we will do the worst case scenario. The worst case scenario is when the reserve bank increase the interest rate every single month. On the table below, we will see what happen if the interest rate go up for consecutive 24 months, each time with 0.25% considering all the fee and upfront cost. This is what will happen:

The “saving” shown on the table is accumulative from the first month. That’s why even the monthly repayment for variable rate is already higher than the fixed rate on 8th month, since you have previous saving, it only become break even on 15th month.

In other words, basically, based on the simulation above,  you will still in advanced should you stay on your variable rate until 14 consecutive months of increases. On the 15th month you can start laughing that “Lucky, I choose the fixed interest rate!”. But before that 15 months, the variable rate still more superior.

Well, maybe you said that increase every one is a bit too harsh. OK, how about an increase every 2nd month?  Here it is:

Fix or Variable ?

You can see that the break even between Fixed Rate and Variable Rate is even further away (28 months – inserting 1 month for every increase)

The SpreadSheet

I have prepared the downloadable spreadsheet shown above that can run on your computer (No macro, no virus – I promised ). Once you downloaded it you can generate your own simulation based on your own condition. This is just a simple spreadsheet but an eye opener.

If you have Microsoft Excel, you can download the XLS file, otherwise you can have the Open Office version: ODS file. (You can download Open Office for free from the internet)

To download, right click your mouse on icon below and select “Save Link As”

Note: any cell with black background and white font indicate that you should change the value to customized to your own number. You can change all the parameter to check your specific “what-if” situation. What if the bank increase by 0.50% instead of 0.25%,what if the “gap” between fixed and variable is not that much , etc.

Conclusion

If the gap rate between fixed rate and variable is too wide, then the answer of “should I fixed my rate or keep it variable” will be “no”. The simulation will prove it to you. But your own circumstances will dictate what’s best for you, so consult with your financial planner if you are not sure. But as I always encourage people to take charge of their own financial matter, you cannot be in state of limbo and unsure of everything. Get the solution and understand it first. Maybe it will take more time, but be it. Your life, your money, your responsibility!

Have a good mortgage shopping and have fun with the simulation !

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