Like with most things, the question of a fixed vs variable mortgage isn’t back and white. There are benefits to both, and can ultimately come down to personal preference.
So, what’s the difference?
Fixed Mortgage Rate
Choosing this option means your interest rate and your overall mortgage payments will stay the same for the entire term of your mortgage loan.
It is not possible to switch out of a fixed rate without breaking the mortgage, to which the penalties are more severe than a variable rate.
Pros
- More predictable than a variable-rate mortgage.
- If you have a Fixed budget, budgeting is much easier.
- You will know exactly when your mortgage will be paid off, if nothing changes over the course of the life of your mortgage.
Con
- Higher penalties for breaking your mortgage for any reason.
- You’re locked into the same interest rate for the entire mortgage term.
- Historical data shows that initial interest rate can be higher than a variable-rate mortgage
Variable Mortgage Rate
With this option, while payments will stay the same, the interest rate can change throughout the mortgage term.
This means differing amounts can go to paying off the principal amount, adding a little uncertainty to when exactly the mortgage will be paid off or making each payment fluctuate.
You can switch from a variable to a fixed rate without breaking your mortgage. However, you will be offered a fixed rate at whatever the current rate is, not what the rate was when you originally entered into the contract.
Pros
- Flexibility to convert to a fixed-rate mortgage at any time.
- Can have a lower initial interest rate.
- The lower initial rate can help you qualify for a larger loan (subject to current Stress Test calculations)
- More of your payment goes towards the principal if the prime rate falls.
Cons
- Less stability in when exactly your mortgage will be paid off.
- If the prime rate goes up, less of your payments will go towards the principal.
Adjustable
There is also a third type, called an adjustable rate. While similar to the variable rate in that it reacts to the prime rate, an adjustable rate means your individual payments can change. However, your amortization period (the time it would take to pay off your mortgage in full) stays the same.
Open Vs. Closed Mortgages
There are an additional two categories that mortgages can fall into: open and closed.
An open mortgage allows you to pay off your mortgage early by increasing a regular payment or through a lump sum, without penalty. However, an open mortgage almost always comes at a significantly higher interest rate offering, as the lender is expecting the borrower to pay off the mortgage early, and they therefore want to make money while they can, and they justify the rate as “convenience” pricing.
A closed mortgage has strict and specific criteria on the types of privileges available to the borrower for making extra contributions toward the principal. In a closed mortgage, the borrower will be penalized for paying off the mortgage early, if it is even allowable at all.
Closed mortgages are more common due to their lower interest rates, however, there are reasons you might choose an open mortgage. You might be expecting an inheritance, a significant increase in your income, or you intend to sell another property to pay off your new mortgage. These are all points that a licensed mortgage professional should address with you during the application stage.
How Is A Variable Rate Calculated?
A variable rate is tied directly to the bank’s prime rate. While each bank sets their own, the five big banks usually have similar same prime rates. That rate is influenced by the Bank of Canada’s interest rate.
That’s a lot of rates.
Basically, the bank will offer a variable rate that equals its prime rate, plus or minus a percentage. So, if the bank’s prime rate is 3% and your rate is prime minus 0.5%, your interest rate will be 2.5%, until the bank announces a change in the prime rate.
Everyone’s situation is different. For some, a standard closed fixed-rate mortgage is the best option, while others might be better off starting in a closed variable-rate mortgage and refinancing down the road.
Fixed vs variable mortgage? It’s a complicated question, and you shouldn’t have to figure it all out on your own. That’s why you need the mortgage brokers at Solid Ground on your side.
