What is best for you might not be what is best for someone else.

So, you’re thinking of getting a mortgage and trying to decide between a fixed or variable rate? The fixed vs variable rate mortgage debate is a tale as old as they come. Let’s break it down for you.

Fixed Rates – How do they work?

A fixed-rate mortgage is the most popular type of mortgage in Canada due to the stability it provides. Although it may not always be the most economical option, many borrowers are willing to pay extra for the security it offers.

There are two types of fixed rate mortgages: Closed and Open. Most mortgages are in a closed term. This means that if you break your fixed rate closed mortgage term, you will incur penalties. With an open mortgage, you can break your term at anytime without any penalty. Most people go with the closed term because they have the best rates. Open mortgage are going to have much higher rates costing you thousands more in dollars if you go the entire term.

Under a fixed-rate mortgage, you pay a consistent interest rate throughout your mortgage term, regardless of whether it is six months, five years, or more extended. On a high level, longer-term mortgages tend to have lower rates. Although fixed mortgage rates may fluctuate, your rate and monthly payment will remain the same.

Pros – Fixed Rate

  • Protection against rate hikes: Your mortgage rate does not change throughout your entire term. So if rates were to rise, your interest rate does not.
  • Easier to Budget: Because your interest rate doesn’t change with the market, neither does your mortgage payment. You will know exactly what your payment will be every month for the entirety of your term. This predictability can make it easier to plan your finances and budget for your mortgage payments.

Cons – Fixed Rate

  • Typically higher rates: Fixed rate mortgages typically have higher interest rates than variable rate mortgages. This means that you may end up paying more interest over the term of your loan, which can add up to a significant amount of money over time. Full disclosure, at the time of writing this (March 16, 2023) fixed rates are much lower than current variable rates.
  • Locked in: Unlike a variable rate mortgage, a fixed rate mortgage does not allow you to take advantage of decreases in interest rates. This means that if interest rates drop, you will still be paying the same higher rate.
  • Extremely high penalties: The penalties for breaking your fixed rate mortgages can be insanely high! The calculation varies from lender to lender and it is impossible to know what your penalty will be because it is usually based on the rate available on the market at the time you are breaking your mortgage. I have seen fixed rate penalties as high as $40,000.

Variable Rates – How do they work?

With a variable rate mortgage, your interest rate moves up and down depending on your bank’s prime rate. Prime rates are heavily influenced by the Bank of Canada’s overnight rate. The Bank of Canada meets 8 times a year to decide if they should increase or decrease the prime rate. That means that your interest rate can technically change up to 8 times a year.

In Canada, for example, between March 2022 and January 2023, the Bank of Canada increased the overnight rate 8 times in a row! The rate went from .25% to 4.25% in less than 1 year!

Variable rate mortgages usually come in 3 or 5 year terms. So, you could see your interest rate changing quite a bit during that time. It could go up, but it could also drop, which can be pretty attractive. Even though we saw some crazy increases in 2022, this isn’t very common. In fact, we have gone several years in a row with very minimal changes to the prime rate.

Pros – Variable Rates

  • Low Penalties: Most variable rate mortgages have a very low penalty to break the term. Usually only 3 months interest.
  • Historically lower than fixed rates: If you look at historical data, most people that took a variable rate mortgage saved more money over the term of their mortgage than if they would have taken a fixed rate.
  • Convertible: Most variable rate mortgages are convertible, meaning you can convert to a fixed rate during the term of your mortgage with no penalty.

Cons – Variable Rates

  • Susceptible to rate hikes: You could potentially pay more interest over your term if rates rise a lot and stay there for a long time. This is the main risk with a variable rate.
  • Payment uncertainty: There are two types of variable rate mortgages: a true VRM and an ARM (Adjustable Rate Mortgage). For a true VRM, your payments are static. This means that your payments stay the same as interest rates rise and fall. However, in a rising rate environment, the payments only stay the same until you hit the “trigger point”. This is when 100% of your payment goes towards interest. Then your payment needs to be adjusted. With an ARM, your payment fluctuates as interest rates rise and fall. If your payment rises, this can eat away at your monthly cashflow.

What rate should I choose?

Choosing between fixed and variable rates is a personal decision. What makes sense for you doesn’t mean it makes sense for your neighbour. Everyone’s situation is different, or how I say it “Every Mortgage Has A Story”. You need to ask yourself some questions:

  1. How long do I plan on keeping this home?
  2. Can I still afford my payment if rates rose by 2%?
  3. Am I OK with taking on some risk?
  4. What are economists saying about the future of rates? (take this one with a grain of salt… they seem to always be wrong…lol)
  5. Is this your “forever home?” or do you think you will need to upgrade?
  6. Is there a possibility for a marriage breakdown? I know this sucks to even ask.. but I have done a lot of spousal buyouts.

These are just a few questions. If you are looking at buying a home, renewing your existing mortgage, or refinancing your home, please reach out and I can help guide you through the process.