Taking advantage of a variable rate mortgage

Posted by admin on May 5, 2009 in Real Estate

If you hold a variable rate mortgage and you are determining whether to switch to a fixed rate mortgage, you may want to do one simple thing in the meantime. Adjust your payments back up to what they were 6 months ago. Why? For the simple reason that now is great opportunity to accelerate your mortgage repayment without affecting your cash flow materially.

As holders of variable rate mortgages now, the interest rate has been declining steadily over the last six months. For example, I went from paying 3.6% interest in December to a recent reset of 1.85% effective in June. In order to keep the amortization period the same, the absolute payment has steadily gone down. My bi-weekly mortgage payment will be 9.1% lower in June than in last December.

The upside of this is there is more free cash at the end of every month but instead of pocketing it, why not up your mortgage payment by the amount of that you were paying 6 months ago? Assuming your cash flow is approximately the same as it was late last year, the affect of this move can be pretty dramatic.

In the Automatic Millionaire, David Bach wrote that there are two ways to pay down your mortgage quickly: (i) add 10% to your current mortgage payment; or (ii) make one lump sum equal to one month’s mortgage payment (assuming your mortgage allows you to do both).

Given that the absolute cost of carrying a variable rate mortgage is falling, one could add 10% to current mortgage payments simply by using the money saved. To see the effect of this move, try to play around with a mortgage calculator to determine your savings over time.

2 Comments on Taking advantage of a variable rate mortgage

By Patrick on May 5, 2009 at 8:18 am

I’m no fan of debt, but what’s the hurry to pay down debt at under 2%? Consider socking it away in a TFSA as long as you have contribution room. That lets you keep your options open. You can always pay a lump sum later if interest rates rise again; in the mean time, the money is still in your hands and you have more flexibility.

By Don on May 8, 2009 at 4:20 pm

While liquidity can be much better than debt free the problem is most people will just out out an spend the extra that they have each month. Split the difference and apply half to the mortgage and have to your savings(IRA, MF, Stocks)