Fixed or variable mortgage rate: How to choose

Share Now

What is a fixed rate?

A fixed rate is when the interest rate remains stable during your years of mortgage repayment. This type of loan usually lasts from a few months to a few decades. This is the most common type of interest rate, as it provides security for the borrower.

What is a variable rate?

The variable rate is an interest rate that changes according to fluctuations in your lending institution’s prime rate. The interest rate on the mortgage is then reset each month, which changes the total amount of your monthly payments.

The differences between these two types of rates?

The fixed interest rate mortgage is primarily for borrowers looking for stability. Unlike the variable interest rate, the fixed rate remains the same throughout the term of the mortgage. The amount of the mortgage payments will not change during the execution of the bank loan contract.

The variable interest rate follows the market trends. It is more suitable for people with a flexible budget, able to withstand an increase in monthly payments.

Advantages and disadvantages of the fixed rate

Advantages

Taking out a fixed-rate mortgage loan ensures that your interest rate is secure throughout the contract. Since the value of this indicator is locked in, you are protected against financial hazards that may affect your monthly payments. The fixed interest rate also gives you peace of mind, as the stability ensures better management of your budget. This option is recommended if you are a first time home buyer or if you are on a tight budget.

Disadvantages

The main disadvantage of the fixed rate is that its index is sometimes higher than the variable interest rate. Your financial institution may ask you to pay an additional premium to guarantee your fixed interest rate. Before taking out a mortgage loan, you should compare the difference between the fixed and variable interest rates. If the difference is too great, the premium may not be worth paying.

The advantages and disadvantages of a variable rate

Advantages

The variable interest rate has the advantage of being lower than the fixed rate. You benefit from an advantageous rate as soon as you sign your contract and benefit from possible rate decreases during the term. This type of rate is less expensive in the long term, allowing you to save on your monthly payments.

Disadvantages

The uncertainty of the market presents a risk if you take out a variable interest rate mortgage. When your bank’s prime rates increase, the amount of interest you pay will also increase, affecting the total cost of the mortgage. It is therefore more attractive to take out a variable interest rate mortgage for a short period of time to avoid the possibility of prime rate increases over a longer period of time.

Definitions of prime and key interest rates

To understand the mechanics of fixed and variable interest rates, you need to know the meaning of certain terms, including prime rate and key rate. Prime rate is defined as the interest rate charged by lending institutions. It fluctuates according to changes in the Bank of Canada’s key interest rate. The Bank of Canada relies on the state of the economy to adjust its rate. This economic situation is itself defined by certain major factors, including unemployment, exports and inflation for example

Factors that influence fixed and variable rates

Fixed mortgage rates are affected by long-term Canadian government bond rates. However, the yields on these bonds vary according to the financial markets, influenced by the economy and the rate of inflation.

Variable interest rates are also affected by the same economic factors. These interest rates fluctuate, however, depending on changes in the lender’s prime rate, which in turn varies with the Bank of Canada’s key interest rate. You should also be aware that the prime rate can change between periods when the prime rate changes.

An interesting strategy

Choosing a mortgage with a fixed interest rate can be more expensive, while a loan with a variable interest rate exposes you to instability in the amount of the monthly payments. An interesting strategy is to choose a mortgage with a variable interest rate, but with the choice of paying a higher amount, as if you were paying back the instalments of a fixed rate loan. This strategy allows you to enjoy the benefits of a variable rate while accelerating your payments. If rates fall, the majority of the payment will return the principal borrowed. On the other hand, the interest will make up the largest portion of the payment if rates rise. You can therefore take out a variable interest rate mortgage and increase your regular payment to what it would have been for a 5-year fixed rate loan, for example. This option will allow you to pay off your principal faster, but also to better anticipate future rate increases.

Can a variable interest rate mortgage be converted to a fixed rate?

Banks can offer their clients who have taken out a mortgage with a variable interest rate to convert it to a fixed rate. This is an option if your interest rate is rising and you want to protect yourself from future increases. However, the lender may give you a higher fixed interest rate than you would have had when you signed the original contract.

Rate changes and prepayment penalties: what you need to know

Before taking out a mortgage, it is important to find out what the penalty is for breaking the contract. The bank will have to take into account the type of mortgage, its amount, as well as the remaining duration of the term. In principle, the penalty is lower if you opt for a variable rate, since it does not take into account the calculation of the rate differential. This penalty often corresponds to three months of interest.

What to do if interest rates go up?

If interest rates go up, you need to consider the impact on your monthly payments, especially if you have a variable rate loan. If your monthly payments represent a significant portion of your budget, it is advisable to optimize your management by evaluating the expenses on which you could make savings.

It is also advisable to increase your savings to anticipate hard times and to face possible interest rate increases. If interest rate increases are expected, you can always convert your variable rate to a fixed rate. Otherwise, you have the option of accelerated repayment, either in a lump sum or in periodic payments when rates are at their lowest.

A variable interest rate mortgage is more attractive when you want to take advantage of lower rates during the term. However, if you prefer to buy your home and plan the payment of your mortgage with peace of mind, a fixed interest rate is preferable. Your mortgage broker is at your disposal to guide you towards the best rate according to your situation.