A fixed-rate or a variable-rate mortgage: which should you choose

Both have their pros and cons.

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October 11, 2022
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When it comes to buying your dream home, most of your energy is spent looking for something that fits all your criteria. Does it have enough natural light? Is it a condo or a house? How much will property tax cost you a year? But, it’s just as equally important to ask: should I choose a fixed-rate or variable-rate mortgage? 

In the world of mortgages, you have the option of two different types of interest rates: a fixed-rate mortgage or a variable-rate mortgage. 

What is a fixed-rate mortgage? 

A fixed mortgage rate is a mortgage rate that does not change over the life of the term, which is usually five years. The interest rate is set at the time you get the mortgage and remains fixed for the life of the loan, regardless of changes in market conditions. This type of mortgage offers you the stability of knowing their monthly payment will not increase over time.

What is a variable-rate mortgage?

A variable mortgage is a type of mortgage where the interest rate can change over time. This can generally be broken down into two types: a variable-rate mortgage (VRM) or an adjustable-rate mortgage (ARM).

In an adjustable-rate mortgage, your monthly mortgage payments can go up or down based on the Bank of Canada’s prime interest rate. However, in a variable-rate mortgage, your monthly mortgage payments won’t change with the prime rate, however the portion of your payments that go towards your interest payment and your principal payment will change.

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In the world of mortgages, you have the option of two different types of interest rates.

Why choose a fixed-rate mortgage? 

A fixed mortgage rate is a great choice for many homebuyers because it offers peace of mind: you know exactly how much your monthly mortgage payment will be for the life of the loan, so you can budget accordingly. Additionally, if interest rates rise in the future, you'll still be paying the same amount each month on your mortgage.

Of course, there are some potential drawbacks to a fixed mortgage rate, as well. For example, you may end up paying more interest over the life of the loan if rates fall after you lock in your rate. However, if you plan to stay in your home for many years, the stability of a fixed rate can be worth the extra cost.

Why choose a variable mortgage rate?

There are a lot of reasons to choose a variable mortgage rate. For one thing, they tend to be lower than fixed mortgage rates. This can save you a lot of money over the life of your loan. Additionally, variable rates can offer more flexibility than fixed rates. You may be able to make extra payments or even pay off your loan early without penalty.

Of course, there are some risks associated with variable-rate mortgages. If interest rates go up, your monthly payments could increase as well. In some cases, rising rates may push you closer to your trigger rate–which, if you’re on a variable-rate mortgage and not an adjustable-rate mortgage, you might end up paying more for your interest than your principal.

Can you switch from a variable-rate mortgage to a fixed-rate mortgage? 

Simply put: yes, you can. You will have the option to convert your loan to a fixed-rate mortgage if you start to feel like you can't handle the risk of a variable-rate mortgage. However, it’s always important to talk to your lender to get a sense of what the current fixed-rate looks like. 

Can you negotiate your interest rates?

You may be able to negotiate on the interest rate a bit. Comparing rates from various lenders is the best way to see what option is best for you. In most instances, negotiating will be in your favour if you have a good mortgage application. 

This can look like having a good down payment and credit history, proof of employment and stable income, and a low debt-to-income ratio. 

How your interest rate impacts your mortgage penalties 

In some situations, you may want to pay off a larger chunk of your mortgage in one go. Doing this without having to pay a penalty is called a “prepayment.” Typically this prepayment can be defined as 15/15 or 20/20–the monthly percentage increase is the first number and the second number is the annual lump sum percentage. 

Example: If you have a prepayment of 20/20 that means you can increase your mortgage payments (whether monthly, bi-weekly, weekly, etc) by 20% per year. Say your home is worth $500,000, that means you’d also only be able to provide a maximum annual lump sum that equals 20%, which in this case is $100,000. 

The amount you’re allowed to pay varies between mortgage lenders, so it’s important to speak to yours about your maximum allowance. 

However, a prepayment penalty is a fee that you may have to pay if: 

  • You pay more than the allowed additional amount toward your mortgage
  • You break your mortgage early, prior to the end of your term 
  • You transfer your mortgage to a different lender, prior to the end of your term
  • You pay off your entire mortgage before the end of the amortization period 

Generally, fixed-rate mortgages will charge you the largest penalty, based on the interest rate differential (IRD)–which is the difference between your original locked-in rate and the new rate for the remaining term of the mortgage. 

If you have a variable-rate mortgage, though, your penalty will be a lot less: on average, it’s about three months’ worth of interest payments. 

Ultimately, it's up to you to decide whether a variable mortgage rate is right for you. Weigh the pros and cons carefully before making your final decision. And, if you need help making that decision one of our mortgage advisors will be happy to help.

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