When you’re in the market for a home, you’re also usually in the market for a mortgage. There are two main types of mortgage in Canada: fixed vs variable rate mortgage. While they each have their pros and cons, there isn’t one right choice. You’ll have to weigh their features against your circumstances to decide which one is right for you. Let’s look at the differences and reasons you might choose one type over the other.
Look at the Numbers
With a fixed rate mortgage, both your interest rate and your payments will remain the same throughout your term. This provides cost certainty for the short term (5 years most commonly) but does not absolve you from market changes over time. Many Canadians with a current fixed rate mortgage that is near maturity right now (June 2022) are feeling some payment shock as their new renewal offer fixed rates are up over 3% higher then what they have been accustomed to paying over the past few years.
Variable rate mortgages are typically structured in one of two ways. Either as an Adjustable rate mortgage (“ARM”) or a Variable rate mortgage (“VIRM”). With a VIRM your payments remain static throughout the term but the rate is variable. If the prime rate changes during the term the principal vs interest within the payment adjusts accordingly. If rates go up then you pay less principal which lengthens the total amortization of the mortgage.
The Adjustable rate mortgage (ARM) consists of a payment structure that also goes up and down based on the prime rate. If this is the case, you’ll need to take a careful look at your budget to make sure you’re able to withstand potential fluctuations in payment amounts. A benefit to this is regardless of the rate changes you’ll keep your amortization (life of your mortgage) on track.
Most Canadians currently hold fixed rate mortgages but this is largely due to the fact that Banks and Mortgage lenders alike push the sale of their fixed products because they are more profitable…So it’s up to you (the consumer) to do your research and select the best mortgage type suited for your needs now and into the future. After a more thorough look you may find there are many good reasons you might choose a variable rate.
First of all, a variable rate is usually lower than the offered fixed rates (At the time of writing this blog they are 2% lower!). Keep in mind that this discount comes with risk. If the prime interest rate goes up, so does your cost of borrowing.
It’s important to do your homework and be aware of what the market is doing. Are you willing to take the risk that you might end up paying more? In March 2022, we saw the Bank of Canada increase the prime interest rate for the first time since it was dropped at the beginning of the pandemic and indications are that rates will continue to rise throughout the rest of the year. This isn’t a reason to panic; it’s just something to be aware of as you look at your mortgage options.
What if You Need to Get Out of Your Mortgage Early?
There are many reasons you might need to get out of your mortgage early. A growing family, a job change, or a move might mean you need to sell before your term is up. It’s important to be aware of what prepayment penalties you’ll need to cover so you’re not faced with any surprises at closing time.
Fixed mortgages generally have much higher penalties for early pay-out. For most lenders, the amount is based on how much interest you have remaining to pay in your term. Basically, by signing the mortgage, you promised the bank that interest and they want to collect. So, depending how far you are into your mortgage term, this can be quite harsh.
On the other hand, lenders usually charge a penalty of three months’ interest to break a variable rate mortgage, offering more flexibility when your plans are uncertain. If you expect you might need to break your mortgage early, a variable rate can save you a lot of money.
Professional Advice Regarding Your Fixed or Variable Rate Mortgage
As you can see, there are a lot of factors involved in your decision to choose a fixed vs variable rate mortgage. Every lender has different terms and conditions, and interest rates vary product to product. The best way to ensure you get the mortgage that is right for you is to talk to a mortgage professional. Our team at HW Advantage can help you navigate your options and find your best solution. Schedule an appointment today.