Kurt Woock
Clay Jarvis
Beth Buczynski
Choosing between fixed and variable mortgage rates typically means choosing between predictable payments and the possibility of lower costs.
If you have a fixed-rate mortgage, your interest rate and mortgage payments won’t change during your mortgage term. If you have a variable-rate mortgage, your rate and payments can fluctuate. That uncertainty creates risk for the borrower, which is why variable rates have almost always been lower than fixed rates.
Fixed-rate mortgage overview
Benefits and risks of fixed-rate mortgages
Benefits:
- Stability. Your interest rate and mortgage payments remain the same during your term.
- Predictable payoff. The projected proportion of each monthly payment that will go toward interest and principal is known at the outset of the term. You can predict exactly how long it will take you to pay off the mortgage.
Risks:
- Higher interest rates. At the onset of your mortgage, fixed rates are often higher than variable rates.
- You’re locked in. If you have a fixed rate and rates drop, nothing changes. You’ll need to renew or refinance (with fees) to get a lower rate.
- High penalties. If you break a closed, fixed-rate mortgage contract, due to selling or refinancing, for example, you could face crushing prepayment penalties.
How a fixed-rate mortgage works
Fixed-rate mortgages are the most popular mortgage type in Canada. Fixed rates give you stability and protect you from rate volatility until the mortgage term is up.
With a fixed-rate mortgage, you pay the same interest rate for your entire mortgage term, whether it’s six months, five years or longer. (The longer the term, the lower the rate tends to be.) Even if current fixed mortgage rates increase or decrease, your rate and monthly payment will remain the same.
Types of fixed-rate mortgages
Closed mortgage. This is the most popular kind of mortgage. A closed mortgage provides limited opportunities to pay off your mortgage early. Breaking a closed mortgage before the end of the term can trigger huge prepayment penalties.
Open mortgage. With an open mortgage, you can repay your entire mortgage ahead of schedule and not face any penalties. Because of the increased flexibility, open mortgage rates may be significantly higher than closed mortgage rates.
Variable rates overview
Benefits:
- Potentially lower costs over time. If interest rates remain the same or fall during your term, you’ll pay less interest with a variable-rate mortgage than you would with a fixed-rate mortgage.
- Minimal break penalties. Most lenders charge three months’ interest if you need to break your variable-rate mortgage contract.
- Ability to switch to a fixed-rate mortgage. Many lenders allow homeowners with a variable-rate mortgage to change to a fixed-rate mortgage at any time.
Risks:
- Unpredictable. If interest rates rise, you could pay more than you would have with a fixed-rate mortgage.
- Converting could cost you more. If you convert to a fixed-rate mortgage, the rate will reflect current interest rates — which might be higher than they were when you took out your mortgage.
How a variable-rate mortgage works
With a variable-rate mortgage, your interest rate follows movements in prime rates. That means the amount of interest you pay can change in any month. You are essentially betting that rates will stay the same or drop during your mortgage term.
Economic volatility can cause unsettling rate changes. Imagine you bought a house in January 2022. By July 2023 your variable mortgage rate could have increased by more than five percentage points. Historically, though, variable rates have rarely ramped up at such a blistering pace.
Variables come in different term lengths, but many last five years. Variable rates are unlikely to remain the same for five consecutive years, so you should expect some rate movement if you go with a variable mortgage. The number of rate changes, the magnitude of those changes and the direction of change are all impossible to predict with much accuracy. There’s a risk your rate could go higher, but there’s also the possibility of it dropping multiple times, which can make variables enticing.
Variable-rate mortgages also come with smaller penalties than fixed-rate mortgages — generally three months’ interest — if you break your mortgage contract mid-term.
Types of variable-rate mortgages
As with fixed-rate mortgages, variable-rate mortgages come in both open and closed varieties. But there are other mortgage types to be aware of.
Fixed payment variable-rate mortgages make up the majority of Canada’s variable-rate mortgages. With these, your monthly mortgage payment stays the same even if mortgage rates change. If rates decrease, more of your payment will be put toward the principal. Yet if rates rise, more goes toward interest. If rates rise significantly, however, and your monthly payment no longer covers your loan’s interest charges, you’ll reach the trigger rate. If you reach the trigger rate, you must work with your lender to find a solution.
Variable rates that don’t have fixed payments are known as adjustable-rate mortgages. With an adjustable-rate mortgage, your actual monthly payments rise and fall in concert with any interest rate changes. Adjustable-rate mortgages have the least amount of predictability and can make it harder for you to budget.
Frequently asked questions about fixed vs variable mortgage rates
If you value certainty, and plan on staying in your home for a while, the extra cost and risk of prepayment penalties associated with a fixed-rate mortgage could be worth it. If you don’t mind the uncertainty, a variable-rate mortgage could save you money if rates drop in the middle of your mortgage term.
Because variable mortgage rates are tied to the state of the Canadian economy, they are very hard to predict. You could take out a variable-rate mortgage right before variable rates rise and stay elevated, leading to months — or years — of higher mortgage payments you may not be able to afford.
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