Buying a home is an exciting time! Of course, it can also be very complicated and there are lots of "i’s" to dot and "t’s" to cross. One of the first things new homebuyers must do is decide whether to choose a fixed rate or a variable rate mortgage. Of course, some homebuyers, especially first-timers moving our of their parents' home or finally saying goodbye to renting, may not even be sure what the difference is!
So, before delving into the pros and cons of a fixed rate vs. variable rate mortgage, let’s be sure we’re on the same page about what exactly they are with some basic definitions.
What Is a Fixed-Rate Mortgage?
A fixed-rate mortgage means that the interest rate of the mortgage will remain the same until the mortgage comes up for renewal (many begin as a 5-year fixed rate mortgage, but others can go much longer).
Fixed-rate mortgages are determined by the Government of Canada’s bond yields at the time of purchase, and doesn’t change even if the bond yields do. Therefore, there are no surprises; you know, month in and month out, how much of your mortgage payment will go toward interest and how much will go toward your principal for the length of the term.
What Is a Variable-Rate Mortgage?
A variable-rate mortgage means that the interest rate of the mortgage will fluctuate throughout the term. It is determined by the Bank of Canada’s lenders’ prime rates, which are the interest rates on loans that the banks are currently offering to their best customers (see the current prime rate here).
The variable mortgage rate is set at prime plus/minus a discount or premium. So, let’s say you're given a mortgage rate of prime -0.5% or prime +0.2%. If the prime rate increases during the term, so does your mortgage rate, and a larger portion of your mortgage payment will be used to pay off interest while a smaller portion will go toward the principal. If the prime rate decreases, the opposite is true.
Simply put, as the prime rate fluctuates over the term, for better or worse, the interest rate on your mortgage will fluctuate too.
Benefits of a Fixed-Rate Mortgage
There really is just one benefit to choosing a fixed-rate mortgage, but for many borrowers, it’s a big one: a fixed-rate mortgage does not change over time. If you live on a strict budget and might have difficulty adjusting it or paying other expenses if your mortgage rate increases, even temporarily or ever-so-slightly, this may be the best option for you. You don’t want an unexpected increase, no matter how small, to cause any undue financial hardship (or anxiety) to you or your family.
Benefits of a Variable-Rate Mortgage
When lenders offer you a mortgage, the variable rate is usually lower than the fixed rate. It may only be lower by only 0.5% or less, but when you’re multiplying that by the hundreds of thousands of dollars you’re borrowing over a few decades, it adds up.
Is there a chance you could end up paying more in the long run with a variable-rate mortgage? It’s possible, if a low variable rate mortgage slowly creeps up, surpasses the fixed-rate, and remains there. However, it’s unlikely. Examined historically, variable rates have proven to be less expensive over time (which we’ll cover in a moment).
It’s also worth noting that, with most lenders, your monthly payment will probably not increase significantly even if the mortgage rate increases; instead, a larger portion of your mortgage payment will go to pay off the interest and a smaller portion will go to pay off the principal (the opposite will be true when the prime rate decreases).
One final benefit of variable-rate mortgages: if the prime interest rate ever starts increasing at an alarming rate, you have the option of locking into a fixed rate for the remainder of the term.
Now, keep in mind that the fixed rate you lock into halfway through your term after the rates have increased will probably not be as good as the fixed rate you were offered at the start of your term; however, once again, the money you could save by initially choosing a lower variable rate over a higher fixed rate may be worth this risk.
Mortgages in Canada: Which is Most Popular?
There are six million Canadian homeowners with mortgages (out of a total of about 10 million homeowners in Canada). The vast majority choose fixed-rate mortgages. According to 2019 Canadian Mortgage Trends:
74% of Canadians have fixed-rate mortgages
21% of Canadians have variable-rate mortgages
5% of Canadians have a hybrid mortgage.
Wait—what’s a hybrid mortgage? As the name implies, it’s simply a combination of fixed and variable mortgages, in which a portion of the loan is set up at a fixed interest rate while the other portion is set up at a variable interest rate. They're not very popular in Canada.
So why are fixed-mortgages the choice of most Canadians? According to Will Dunning, Chief Economist of MPC, “[In 2019], the lack of a cost advantage for variable rates, and with expectations for most of the year that variable rates were unlikely to fall for some time, caused a large majority of active borrowers to choose the security of a fixed rate.”
Mortgages in Canada: Which is Right for You?
History tells us that variable-rate mortgages save homeowners money in the long run. RateSpy, which compares thousands of mortgage rates in Canada from 296 companies, including TD mortgage rates, CIBI mortgage rates, RBC mortgage rates, and Scotiabank mortgage rates, reveals that variable mortgages have outperformed fixed-rate mortgages for well over three decades. Still, many Canadians are risk averse, and fixed mortgage rates tend to provide the peace of mind that the rate will not change for the duration of the term.
Ultimately, when deciding upon your Canada mortgage, it’s up to you, the homebuyer, to determine whether you want a fixed-rate mortgage or a variable-rate mortgage. Always do your homework, speak with multiple lenders, and ask yourself the following questions:
How large a mortgage payment can I afford today?
Could I still afford a variable rate if interest rates rise?
How long will I live on the property?
In what direction are interest rates heading? Are they expected to continue this trend?
Additional Mortgage Resources
To help with your mortgage decision-making, be sure to check out some of our other popular home buying and mortgage blogs:
Choosing a mortgage is a big decision, especially if you’re already carrying a lot of debt. We can help you with the latter! If you’re dealing with debt and looking for a way out, or just looking for an ear, our Credit Counsellors are here for you. All of our counselling is free, confidential, and non-judgmental. Call us at 1.800.267.2272 to book a phone appointment or contact us online.
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