Nov. 2021 – 15 min read
- How does a fixed-rate mortgage work?
- How does a variable rate mortgage work?
- Comparing fixed-rate and variable-rate mortgages
- Is a variable-rate mortgage better than a fixed-rate mortgage?
- Can you switch from a variable-rate to a fixed-rate mortgage?
- Can you negotiate a fixed-rate mortgage?
- Prepayments and penalties
- Variations of fixed and variable-rate mortgages
- How the prime rate affects variable mortgage rates
- What’s an interest rate cap?
- Historical comparison of fixed-rate and variable-rate mortgages
With a fixed-rate mortgage, the interest rate and your mortgage payment will remain the same throughout your mortgage term.
With a variable-rate mortgage, your mortgage payment will stay the same throughout your mortgage term, but the interest rate can go up and down along with the prime interest rate.
Comparing fixed-rate and variable-rate mortgages
Because interest stays the same, you’ll always know when you’ll pay-off your mortgage
Easier to understand than a variable-rate mortgage
You’ll have confidence knowing what to budget for mortgage payments
The initial interest rate is often lower than a fixed-rate mortgage
An initial lower payment may help you qualify for a larger loan
If the prime rate falls and your interest rate falls accordingly, more of your payments will go towards the principal
You can convert to a fixed-rate mortgage at any time
The initial interest rate is often higher than a variable-rate mortgage.
You’re locked into your interest rate for your entire mortgage term.
If you break your mortgage for any reason, penalties will likely be greater than a variable-rate mortgage.
If the financial uncertainty of a variable-rate mortgage doesn’t scare you, in a low-interest rate environment, a variable-rate mortgage could be a better choice because the rate is likely to be lower than a fixed-rate mortgage, which can save you a lot of money.
However, if you like knowing your mortgage payment will stay the same, regardless of if mortgage rates rise or fall, then a fixed-rate mortgage is your best choice.
You can change your mortgage rate type at the end of your term when you renew your mortgage.
Some lenders also allow you to convert your variable rate to a fixed rate during your initial term.
The short answer is yes, but not always.
You may be able to negotiate on the interest rate a bit. It pays to compare rates from various lenders. If you find a lower rate elsewhere, by all means ask your lender if they can match it or do even better.
Often, you’ll have the most luck negotiating if you have an attractive mortgage application. That includes a good down payment and credit history, stable income and low debt service ratio. If you already have other products with the lender (i.e. investments, insurance or even a credit card) you may also get a better rate.
A prepayment is how much you pay down on your mortgage on top of regular payments, without having to pay a penalty. It will vary depending on the mortgage lender.
A prepayment penalty is a fee that your mortgage lender may charge if you:
- Pay more than the allowed additional amount toward your mortgage
- Break your mortgage contract
- Transfer your mortgage to another lender before the end of your term
- Pay back your entire mortgage before the end of your term, including when you sell your home
You’ll likely pay the largest penalty with a fixed-rate mortgage. It’s usually based on the interest rate differential (IRD) which is the difference between your original locked-in rate and the interest rate your lender is currently charging. Ask your lender for a clear breakdown of IRD costs.
With a variable-rate mortgage, the prepayment penalty will likely be much less, often about 3 months of interest payments. However, once again, contact your lender for an exact penalty calculation.
Canada’s prime rate is the interest rate that most Canadian major banks charge their best customers. The prime rate varies with performance of the Canadian economy and inflation forecasts.
With a variable-rate mortgage, the interest rate you pay is tied directly to the prime rate and will move up and down with the prime rate.
If the prime rate falls, more of your payment goes towards to the principal. This means, you pay off your mortgage faster.
However, if the prime rate rises, more of your payment goes towards the interest, and less to the principal, meaning it could take you longer to pay for your home. If the prime rate increases to a specific percentage or trigger point (listed in your mortgage contract), your lender may increase your payments to ensure you pay off your mortgage by the end of the amortization period.
If you have a tight budget, an increase in your mortgage payment may impact your ability to make your mortgage payment or take care of other household expenses.
To protect yourself if interest rates rise, you may want to ask your lender about an interest rate cap. This is the maximum interest rate your lender can charge on your mortgage. Even if interest rates increase, you won’t have to pay more than the maximum cap.
Variable-rate mortgages have been historically proven to be less expensive. That said, According to Mortgage Professionals CanadaOpens a new website in a new window, about 77% of all mortgages are fixed rate, while the remainder are variable rate (18%), or a combination of fixed and variable rate (5%).
Now that you understand more about fixed-rate and variable-rate mortgages, you may want to contact your advisor and a credit planning consultant to:
October 21, 2019