When it comes to getting a mortgage for the first time, there’s a lot that might not be familiar to you. But one thing you may have heard prior to starting your research is the debate about fixed vs variable rate mortgages. While talking to a mortgage broker is the best way to understand both options, when you talk to someone is your choice! In this blog post, we’ve broken down the basics of fixed and variable mortgages to help you get started.
What are Fixed Rate and Variable Mortgages?
Of the many different types of mortgages available, fixed-rate and variable mortgages are two of the most popular.
A fixed-rate mortgage refers to the interest rate, which stays the same over the term of the mortgage. Once locked in, the interest rate does not change with market conditions. This means that if you get a low-interest rate (such as now in our post-pandemic time), you will keep that same low rate even if interest rates increase over time.
A variable-rate mortgage is a mortgage whose interest will fluctuate over time. This is based on the Bank of Canada’s prime rate. Unlike a traditional bank, the Bank of Canada is not a commercial company and doesn’t provide services to the public. Instead, its role is to “promote the economic and financial welfare of Canada”.
As part of its duties, the Bank of Canada examines and adjusts the prime rate periodically throughout the year. With a variable rate mortgage, you can take advantage of lower rates when they happen. “For example, we can offer you 1% lower than the prime rate (2.45%),” says Mortgage Design Group Inc. broker Rachel Ambler. “That means your mortgage interest rate would be 1.45%.”
Why Get a Fixed vs Variable Rate Mortgage?
A fixed-rate mortgage is great for those who are looking for a consistent payment each month. This allows you to properly budget and plans your finances. Because of the stable nature of fixed-rate mortgages, they can also give you security and peace of mind. “With the inconsistency of the economy right now with the pandemic and uncertainty about your job or hours, it’s really nice to know what your payments will be,” says Rachel.
A fixed-rate mortgage is also great if you are looking to lock in a low interest rate. With interest rates at a historical low, you could take advantage of them for the next 5 to 10 years, depending on your mortgage term.
Why Get a Variable vs Fixed Rate Mortgage?
Historically, variable-rate mortgages tend to have a lower rate than fixed-rate mortgages. When asked how to best take advantage of variable-rate mortgages, Rachel has a recommendation. “If a client is comfortable going with variable rates, I always recommend that they budget and make payments as if they were on a fixed-term,” she says. “For example, if you plan for 2% instead of the 1.45%, you’re actually preparing yourself in case that variable rate has a slight increase.”
Another perk to doing this, according to Rachel, is that you are also able to pay down your mortgage principal. If you make monthly payments of 2% instead of 1.45%, the excess goes towards the base amount of your mortgage. That means that you may be able to pay off your mortgage more quickly! “You’d be surprised how quickly it can decrease your mortgage balance!” adds Rachel.
What Should You Be Aware Of?
Sometimes your mortgage isn’t working out for you and you need to break it to find new, better terms. If this happens, you are likely to face payout penalties. If you have a variable rate mortgage, your penalty is always the equivalent of three months' interest. This makes it easy to calculate yourself, or you can ask your mortgage broker to calculate it for you.
With a fixed-rate mortgage, it can be one of three months interest or interest rate differential, whichever is the higher of the two. “Interest rate deferential is a calculation based on the difference between your rate, the lender’s current rate, your balance, and how much time you have left,” explains Rachel. “It pretty much calculates the interest that your bank is missing out on by ending your term early. Often, your payout penalty is higher [than a variable mortgage].”
While it may seem like there’s a lot going for variable-rate mortgages, it’s important not to discount the value of stability. The Bank of Canada examines—and potentially adjusts—the prime rate about 8 times a year. That means that your mortgage may possibly fluctuate more over the years.
How Do You Know Which One is For You?
If you find it hard to choose between a fixed vs variable rate mortgage, you’re not alone! This is a question that many brokers at Mortgage Design Group Inc. get.
“We have a super fancy calculator,” Rachel answers with a laugh when asked how she can help people who are undecided. “We can put all your information in, the mortgage amounts, and the different rates to calculate what your savings would be with either option. We can also calculate roughly what your balances would end up being so we can show you the difference if you do decide to go with one over the other. This helps everyone make an educated decision.”
At Mortgage Design Group Inc., we have a goal to demystify the mortgage process, making it easily understandable and accessible to everyone. With free world-class service that is available to everyone from the comfort of their own home, we’re always excited to share our experience and knowledge in order to help you. Our goal isn’t just to help our clients get a mortgage—we want to help them save money.