Fixed vs. Variable Rates

A decision a lot of homebuyers and homeowners struggle with is whether to go with a fixed or variable mortgage. Both have their differences and similarities. In this article we’ll look at the differences between the two mortgage types and how the Canadian Mortgage App can help make your decision easier.

Fixed vs Variable Mortgage

Fixed Mortgage Rates

If you’re looking for predictability, look no further than the fixed rate mortgage. With a fixed rate mortgage, your mortgage payment and rate remain the same for the length of your mortgage term. When you sign up for a fixed rate mortgage, you’re “locking in.”

Fixed rate mortgages are great for first-time homebuyers or anyone who is not comfortable with taking risks. Someone who would sleep better at night knowing exactly what their mortgage rate and payments will be for the foreseeable future. When you have a fixed rate mortgage, budgeting is a lot simpler. That’s because you won’t have to stress about your mortgage payments increasing during your term.

While this may sound great, there is a cost to fixed rate mortgages. Mainly, you’ll almost always pay a higher mortgage rate with fixed rate versus variable rate.

In Canada the most popular mortgage is the five-year fixed rate. The pricing of fixed rate mortgages is based on what’s happening in the bond market. When bond yields are down, fixed mortgage rates go down and vice versa.

A key difference between fixed and variable rate is how the mortgage penalties are calculated. We discussed this in depth in the last article. Because of how the penalties are calculated, with a fixed rate mortgage you can end up with a substantially higher mortgage penalty, especially if you’re breaking a mortgage with the banks.

This could also be a problem for many Homebuyers considering that in Canada roughly 2 out of 3 people break their mortgages within the first 5 years.

For many people a fixed rate is worth it but or some it isn’t and that’s when they may choose to go with the next mortgage type we’re going to talk about – variable rate.

Variable Mortgage Rates

If you are comfortable with taking a little risk to save money, and may be willing to break your mortgage before the end of the term, then a variable or adjustable rate mortgage may be for you. 

With a variable rate mortgage, the mortgage rate is almost always lower than the fixed rate, however, there’s a catch – your rate and interest payments might change at any point in your mortgage term.

This usually happens when your mortgage lender changes its prime rate (a lender usually changes its prime rate based on the Bank of Canada changing interest rate).

The Bank of Canada has eight scheduled interest rate announcements in the year, although as we’ve learned from COVID-19, it is possible for our central bank to make emergency interest rate cuts at an unscheduled time. A variable rate mortgage makes the most sense when interest rates have stabilized or are going down.

Mortgage lenders express variable mortgage rates as prime rate plus or minus a spread.

For example, if a mortgage lender is offering you a variable rate mortgage at prime less 0.5 percent and the prime rate is 2.45 percent, then your rate would be 1.95 percent.

If you’re looking to be mortgage-free sooner, a variable rate mortgage can make sense. With a lower rate than the fixed rate, you could set your mortgage payment to be the same as the fixed rate and pay down your mortgage sooner.

If you choose variable rate and you find yourself in a situation where interest rates are rising, most lenders allow you to lock into a fixed rate mortgage at no cost (although your lender may not offer you the best rate since it knows your only other alternative is to break your mortgage).

Speaking of breaking your mortgage, as mentioned in the last section a key difference is the penalty. Variable rate mortgages almost always have a lower penalty than fixed rate. That’s because with most variable rate mortgages you’ll only ever have to pay three months’ interest as the penalty.

If you like the stability of a five year mortgage term, but there’s a good chance you could sell the property before the end of the term, you might consider signing up for a variable rate mortgage due to the fairer mortgage penalties.

The Bottom Line

Not sure whether to go fixed or variable? The Canadian Mortgage App is here to help! Using the Compare Side By Side Tool , you can easily switch between the two to compare rates and payments, letting you choose the mortgage type that makes the most sense for you.

 

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