When you’re getting a mortgage, one of the biggest decisions you’ll make is choosing between a fixed mortgage rate and a variable mortgage rate. It’s easy to focus on which rate is lower today, but the right mortgage isn’t necessarily the one with the lowest starting rate. Your income, budget, comfort with changing payments, financial goals and expectations for interest rates can all play a role in determining which mortgage option is best for you. So, what are the differences between fixed vs variable mortgage rates? How do you decide which one is right for you?
Let’s break down these two mortgage rate types available in Canada.
What Is a Fixed Mortgage Rate?
A fixed-rate mortgage means your interest rate stays the same for the entire mortgage term.
For example, if you choose a five-year fixed mortgage, the interest rate you agree to at the beginning of your term will remain the same for those five years, regardless of what happens to market interest rates.
This makes a fixed mortgage an attractive option for homeowners who value stability and predictable mortgage payments.
Benefits of a Fixed Rate Mortgage
Predictable payments
With a fixed mortgage rate, your mortgage payment remains consistent throughout your term. This can make monthly budgeting much easier because you know exactly what your mortgage payment will be.
Protection from rising interest rates
If interest rates increase during your term, your mortgage rate doesn’t change. You’re protected from increases in your mortgage payment caused by rising rates.
Less need to monitor interest rates
If you don’t want to spend time watching the Bank of Canada, lender rates or changes to prime, a fixed mortgage can provide peace of mind. You know your rate is locked in for the term. Although we do still recommend keeping an eye on the rates. If they drop significantly it can be worth breaking your term to take advantage of those.
What Are the Drawbacks of a Fixed Mortgage?
The starting rate may be higher
Fixed mortgage rates are often higher than variable rates when you first take out the mortgage. That means you may pay more interest initially in exchange for the certainty of a fixed payment. How much variation between the fixed and variable rates depends on current market conditions.
You may not benefit from falling interest rates
If mortgage rates decrease after you lock into a fixed mortgage, your rate doesn’t automatically decrease with them.
You generally have the option to break your mortgage and refinance into a new mortgage at a lower rate. Doing so can result in a penalty. As mentioned above sometimes this can be worth it, but in many cases it is not.
You also have the option of choosing a shorter fixed term, such as 1, 2 or 3 year terms, if the rates are higher and you think they may come down before too long. However, this is essentially trying to time the market and that is a very challenging thing to do correctly.
Potentially higher penalties for breaking the mortgage
One of the biggest considerations with a fixed mortgage is the potential cost of breaking the mortgage before the end of the term.
Depending on the lender and the circumstances, a fixed mortgage penalty may be calculated using either 3 months interest or an Interest Rate Differential (IRD), whichever is greater. The IRD penalty can be quite high in certain situations.
This is particularly important if you think you may sell your home, refinance or otherwise need to break your mortgage before the term ends. In those cases you may decide to choose a shorter term for other reasons than just trying to time interest rates.
What Is a Variable Mortgage Rate?
A variable-rate mortgage has an interest rate that can change throughout your mortgage term.
In Canada, variable mortgage rates are generally expressed as a discount or premium to the lender’s prime rate.
For example, if your mortgage rate is Prime – 0.50% and your lender’s prime rate is 5.00%, your mortgage rate would be 4.50%.
When the lender’s prime rate changes, your variable mortgage rate will generally change as well, based on the discount or premium you originally received.
Using the same example, if the lender’s prime rate decreases from 5.00% to 4.50%, your mortgage rate at Prime – 0.50% would decrease from 4.50% to 4.00%.
That means a variable mortgage can provide savings opportunities when rates decrease. It also means you need to be comfortable with the possibility of your rate increasing.
Benefits of a Variable Mortgage
Potentially lower starting rate
Variable mortgage rates can often start lower than comparable fixed rates which means savings right off the start of your mortgage. If the rate remains favourable, this can result in lower interest costs overall.
You can benefit when rates decrease
If prime decreases, your variable mortgage rate generally decreases as well. Depending on the mortgage structure, this can reduce your payment, increase the amount going toward principal, or both.
Generally lower prepayment penalties
Variable mortgages typically have a penalty of three months interest if you break the mortgage during the term.
This can make a variable mortgage more flexible for homeowners who think they may sell or refinance before the end of their term.
You may be able to lock into a fixed rate
Many variable-rate mortgages allow you to convert to a fixed-rate mortgage with the same lender during the term without a penalty.
This can give you the option to lock in your rate if you feel rates are starting to rise, or take advantage of securing a lower rate if fixed rates drop to a level that you’re comfortable with.
Drawbacks of a Variable Mortgage
Your rate can increase
The biggest trade-off with a variable mortgage is that your interest rate isn’t guaranteed to stay the same. The unpredictability can make it a product that some would not be comfortable with.
Payments or interest costs can change
Depending on how your variable mortgage is structured, an increase in rates can result in a higher mortgage payment or a greater portion of your payment going toward interest.
This can make it more difficult to predict exactly how much your mortgage will cost over time.
You need to be comfortable with some uncertainty
A variable mortgage isn’t necessarily a “set it and forget it” option. You’ll want to pay attention to market conditions and changes to interest rates.
If you choose a variable rate, you should understand how changes in prime could affect your mortgage. Make sure you have enough room in your budget to handle potential increases.
We advise all our clients on variable rates to call us anytime to discuss current rates and their available options.
Fixed vs. Variable Mortgage: Which Is Better?
There isn’t one mortgage rate that is best for everyone.
The better question is, which mortgage rate makes the most sense for you and your financial situation? A qualified and experienced Mortgage broker can help you figure out which product makes the most sense for your needs.
Don’t Choose a Mortgage Based Only on Today’s Rate
One of the most common mistakes borrowers make is choosing a mortgage solely because it has the lowest rate advertised today.
Your mortgage is likely to be one of the largest financial commitments you make. The rate is only one piece of the puzzle. There are many other important factors that should be considered when choosing your mortgage product.
Things such as prepayment privileges, mortgage penalties, portability, flexibility and the type of lender can all be important depending on your situation.
This is where working with a mortgage broker can be helpful. Rather than simply looking at the lowest rate, we can help you compare the overall mortgage product and determine which option makes the most sense for your specific circumstances.
A mortgage with a slightly higher rate may ultimately be a better fit if it provides features and flexibility that are important to you.
The Bottom Line
Choosing between a fixed and variable mortgage ultimately comes down to getting the mortgage that fits your financial situation, your plans and your comfort level with risk.
A fixed mortgage gives you the comfort of a predictable rate and payment. A variable mortgage gives you the opportunity to benefit from changing interest rates but requires you to accept more uncertainty. Both have certain levels of possible risk and reward.
If you’re not sure whether a fixed or variable mortgage is right for you, a mortgage professional can help you compare the options based on your specific circumstance not just the rate being advertised today.
Jessica Kriekle
Advance Mortgage
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