When shopping for a mortgage, Canadians have a choice between fixed-rate mortgages and variable-rate mortgages.
In Canada, the majority of mortgages are fixed-rate. As of recent years, approximately 70% to 75% of all mortgages in Canada are fixed-rate mortgages. This preference for fixed-rate mortgages is due to the stability and predictability they offer, as borrowers are protected from interest rate fluctuations during the term of the mortgage.
Yet, this wasn’t always so, and there was a time when variable-rate mortgages reigned supreme. Variable-rate mortgages ruled the marketplace when interest rates were low and stable, especially during the early 2000s, after the 2008 financial crisis, and again in 2015, when the Bank of Canada maintained a low-interest-rate environment in response to global economic uncertainties and low inflation. This led to a resurgence in the popularity of variable-rate mortgages, as the interest rate savings over fixed-rate mortgages were appealing to many borrowers.
Today, much is changing again, and there is a lot to consider when choosing a fixed or variable-rate mortgage.
Which Mortgage is Best for You?
Fixed-Rate Mortgages
A fixed-rate mortgage is a type of home loan where the interest rate remains constant throughout the entire term of the loan. This means that the borrower’s monthly mortgage payments stay the same for the duration of the mortgage, regardless of changes in market interest rates.
Customers like fixed-rate mortgages because:
Stable Payments
Since the interest rate does not change, the monthly payments for both the principal and interest remain the same over the life of the loan. This provides predictability, making it easier for homeowners to budget.
Terms
Fixed-rate mortgages come in terms of 1,2,3,4,5 7 and 10 years although other term lengths can be available depending on the lender. This flexibility allows borrowers to choose a mortgage term and strategy that is right for them.
Interest Rates
The interest rate on a fixed-rate mortgage is presently lower than that on variable-rate mortgages but that isn’t always so. Fixed-rate mortgages offer protection to the borrower from rate increases during the term of the mortgage. It also prevents borrowers from taking advantage of declines in interest rates during the term of the mortgage.
Read More:
How to Optimize Payment Frequency for a Fixed Mortgage
How to Choose the Right Term Length for a Fixed Mortgage
Breaking Your Mortgage: Canada vs United States
Variable Rate Mortgages
A variable-rate mortgage is a type of home loan where the interest rate can change periodically based on the performance of a specific benchmark or index, such as Canada’s prime rate. Unlike a fixed-rate mortgage, where the interest rate remains constant for the entire term, the interest rate on a variable-rate mortgage fluctuates over time, which can lead to changes in the amount of the monthly mortgage payment (ARM) or payments remain constant with changes to the amount of principle paid (VRM).
Customers like variable rate mortgages because:
Interest Rate Fluctuations
The interest rate on a variable-rate mortgage is typically tied to the lender’s prime rate, which can fluctuate based on changes in the Bank of Canada’s key interest rate. When the prime rate changes, the interest rate on the mortgage adjusts accordingly. Borrowers can take immediate advantage of decreases in interest rates, unlike those in a fixed-rate mortgage.
Payment Structure
Some variable-rate mortgages in Canada offer fixed payments (VRM), where the payment amount remains constant, but the portion of the payment going toward interest versus principal changes as the rate fluctuates. Other variable-rate mortgages have floating payments (ARM) that adjust in response to interest rate changes.
If rates rise and payments are fixed, a greater portion of the payment goes toward interest, potentially reducing the amount applied to the principal. Conversely, if rates drop, more of the payment goes toward reducing the principal.
Term and Amortization
Many variable-rate mortgages in Canada allow borrowers to convert to a fixed-rate mortgage at any time without penalty, locking in the rate for the remainder of the term. Variable-term mortgages tend to be limited to 5 years, unlike fixed-rate mortgages, which offer many more term choices.
Penalties
If a borrower breaks a variable-rate mortgage before the end of the term, the penalty is usually three months’ interest, which is generally less expensive than the Interest Rate Differential (IRD) penalty typically applied to fixed-rate mortgages.
Risk and Reward
When interest rates are stable or falling, variable-rate mortgages can offer lower interest costs over time compared to fixed-rate mortgages. The key risk is that rates can increase, leading to higher interest costs and potentially higher payments if the payments are not fixed.
Which Mortgage is Best for You?
Fixed-rate mortgages are ideal for borrowers who prefer the stability of predictable payments. It’s also a good option during periods of low interest rates, as the borrower can lock in a low rate for the entire term of the mortgage.
Variable-rate mortgages are best for clients who are more risk-tolerant and are comfortable with increases in interest rates. Such borrowers are also likely to want to take immediate advantage of declines in interest rates so they can become mortgage-free faster. They are also not as sensitive to increases in monthly mortgage payments due to their higher income levels and disposable income.
