Are variable rate mortgages really that scary?

This is a loaded question. I originally wrote this article back in 2019 and since then we have experience a massive change in the world – The COVID-19 Pandemic. While the mortgage and real state market has changed quite drastically, my opinion on variable rate mortgages hasn’t changed much.

Before I can answer this question, I want to explain what a “Variable Rate” actually is. 

What is a Variable Rate Mortgage?

A variable rate mortgage is a type of mortgage you would obtain when buying a house. This type of mortgage is considered a higher risk than it’s counterpart “the fixed rate mortgage”. A variable rate mortgage is based off the lenders current Prime Rate. When you lock into this rate, they usually offer a discount or added premium to their prime rate.

Lenders base their prime rates on the Bank of Canada’s (BoC) overnight rate. If the BoC decides to increase or decrease their overnight lending rate, lenders typically follow by increasing or decreasing their prime rate. 

For example, if you sign a 5 year variable mortgage at Prime – 1%, your rate will be whatever the current prime rate is MINUS 1%. At the time of writing updating this blog post, most lender’s prime rates are at 3.95% 2.45% (TD has a higher prime rate for mortgages for some reason…). This means your interest rate on your mortgage would be 3.95% 2.45% MINUS 1% = 2.95% 1.45%. If the prime rate rises or falls, so does your interest rate. 

So, are Variable Rate Mortgages that scary??

The media is going wild with variable rate increase speculation. And they aren’t really wrong. We are probably going to see another increase or two in the near future. However, even though your rate may increase during your term, it doesn’t mean you should be scared of considering a variable rate.

Here there are a few reasons why someone may take a variable rate mortgage:

  • Most variable rates calculate their buyout penalty as “3 months interest”. This is typically one of the lowest penalties for breaking your mortgage term.
  • Historically, people that have taken out variable mortgages have saved more money on interest (on average) than people that took out fixed mortgages.
  • You like to take risks! As stated above, variable rate mortgages carry a higher risk than that of a fixed. Especially in a rising rate market. However, you can mitigate this risk by utilizing a few strategies I will talk about below.

How to get the most out of your variable mortgage

When getting a mortgage, you are deciding whether you should take a fixed or variable mortgage. If the interest rate is different (which they most likely are) than so will your mortgage payment. Typically, the variable rate will be lower than the fixed, so you can expect your mortgage payment to also be lower. To maximize your interest savings, I recommend that you increase your mortgage payment to the amount that you would have been paying if you took the fixed rate mortgage. This extra money goes directly towards the principal of your mortgage which pays off your mortgage faster, and in turn, save you money on interest. Using this strategy also help mitigate the risk of variable rates increasing mid-term of your mortgage.

Take a variable mortgage – or Don’t… But do.

So my advice to you: Take a variable rate mortgage – or Don’t. It is entirely up to you. However, educate yourself on the pro and cons of taking the fixed or the variable rate mortgage. Using a mortgage profession, such as myself, can help guide you in the “right-for-you” direction. Every mortgage is different, and everyone has a different mortgage story. Let me help you with yours.

Editors note: I originally wrote this article in 2019 and updated it in 2022. I also was featured in The Financial Post talking about variable rate mortgages. You can read the article here: Financial Post.