Fixed vs. Variable Mortgage Rates

Fixed-Rate Mortgages vs. Variable Rate Mortgages

A proud and happy moment for any Canadian family is the purchase of a new home. As no two families are alike, no two family’s mortgage needs are alike either.

Many find themselves faced with a difficult decision when purchasing a new home: choosing a fixed-rate mortgage or a variable rate mortgage.

What’s the main difference between a variable rate and a fixed-rate mortgage?

These two mortgages are aptly named. A fixed-rate mortgage is relatively simple because from inception to completion of the loan’s lifetime, you have an interest rate that doesn’t change. On the other hand, a variable-rate mortgage has an interest rate that will vary based on its unique relationship to the prime lending rate as set forth by the lender. Your mortgage’s variable rate will be the prime rate +/- a specific number initially agreed upon in your loan documents. An example of a variable rate would be the Prime lending rate minus 0.5%. So even though the prime rate might change, your rates relationship to it will remain constant. If the Prime rate is 5% and your mortgage rate is Prime – 0.5%, your current interest rate would be 4.5%.

What are the pros of choosing a fixed-rate mortgage?

The apparent upside is that no matter what is taking place in Canada’s housing market or the stock market, the interest rate and your overall payments won’t change. If you choose a five-year fixed-term mortgage, you will have equal payments for each of those 60 months. The fixed-term is not to be confused with your amortization period. The amortization period is the amount of time it takes to satisfy your mortgage’s financial terms fully. Typically, this will fall in the 25 years plus range. Recent data indicates two-thirds of Canadians choose a fixed-rate mortgage over a variable rate. Interestingly enough, most applicants for fixed-rate mortgages tend to be part of the younger demographics, with variable-rate mortgages skewing towards the more senior crowds.

What are the cons of choosing a fixed-rate mortgage?

While a fixed-rate mortgage is a far more stable choice for planning out your budget, it also tends to have a higher interest when in comparison to variable-rate mortgages. Lenders see fixed-rate mortgages as a slightly higher risk to them and therefore tend to levy it with a higher interest rate to compensate.

What are the pros of choosing a variable rate mortgage?

Over the last 15 years, there are only two years (2007 and 2019) where the average variable rate surpassed fixed-rate mortgages’ value. Variable-rate mortgages tend to be the lower risk for lenders, and a lower interest rate is attached to them accordingly. If you were to choose a three year variable rate mortgage that averages even half a percentage point lower than its fixed-rate counterpart, the savings to you during this time could be into the thousands of dollars.

What are the cons of choosing a variable rate mortgage?

The one major downside to a variable rate mortgage is right in the name itself. Due to the nature of a variable rate, you might end up paying a higher rate throughout your mortgage in the event of massive market fluctuations. Not being able to forecast payments accurately can cause significant financial stress that causes undue anxiety. Make a judgment not only concerning your financial health but the overall health of the economy.

Choosing the mortgage type that’s best for your situation

If you are a younger Canadian looking to secure your first mortgage, you may choose the stability that comes with a fixed-rate mortgage and forgo the advantages you might find with a variable rate. The chances are likely that you will pay more each month to opt for the stability that comes with a fixed rate, but first, you should decide just how much more you’re ok with paying. Crunch the numbers, calculate what you would be paying with the current fixed interest rate, and pay with the likely lower variable rate. When you find out what the difference is between the two rates, you then need to ask yourself if you’re willing to pay that amount for your peace of mind. If the amount is just too significant, you could also go with a variable rate mortgage and apply your monthly savings directly to your principal amount, decreasing your overall amortization period. Whichever you choose, please keep in mind that a difference in your interest rate of even 0.25% over your mortgage’s full lifetime can mean the difference in thousands and thousands of dollars.

Remember, don’t be afraid to seek out advice. It’s imperative to speak with as many financial consultants and experts as possible and shopping around for the best rates from various lenders. Gather as much information as you can before making an informed decision. If it looks as though the fixed interest rate has bottomed out, it might be the right time to lock that in for a term. If, however, it looks as though the variable rate is so much lower as to be too attractive to pass up, perhaps that should be the way to go.