How To Choose Between A Variable Rate and Fixed Rate Mortgage?
I often get the question, “what’s your best rate?”
Well, the reason I don’t usually like talking about fixed or variable interest rates at the beginning of any mortgage conversation is that ‘the best rate' depends on a number of things.
Interest Rate Basics
The primary difference between a fixed or variable rate mortgage is how much you will pay monthly in interest.
With a fixed-rate mortgage, the amount you pay each month will stay the same for the entire length of your mortgage term. If you like consistent payments each month that don’t change, a fixed rate is a good option.
With a variable-rate mortgage, the amount you pay can potentially change each month, as the interest will change based on the prime lending rate set by the Bank of Canada.
Prime rate is the interest rate used by your lender or bank when lending to clients. Their Prime rate is affected by The Bank of Canada’s overnight lending rate.
If you are the type that can’t sleep at night knowing that your rate may change by .25%, a variable rate mortgage may not be the best option for you.
Different Types of Variable Rate Mortgages
Whenever those in the mortgage industry are talking about a mortgage product that isn’t a fixed rate, we tend to just use ‘variable rate’ as the blanket term.
A variable rate mortgage is a type of floating rate mortgage. As mentioned, this means your interest rate is dependent on the Prime rate.
When the Bank of Canada changes its lending rate, it trickles down to you, the consumer. This year, the Bank has made a few rate increases which have increased interest rates for variable-rate mortgage holders.
While your interest rate may increase, your payment will likely not increase.
All it means is that more of your payment will go towards interest versus your principal. If rates fall, more of your payment will go toward the principal.
Adjustable Rate Mortgages
Nearly everything about an adjustable-rate mortgage is the same as a variable-rate mortgage. It’s a type of floating rate mortgage, impacted by changes made to the overnight lending rate by the Bank of Canada.
The main difference is your payment amount.
When interest rates change, your mortgage payment will change.
If rates rise, your payment will increase. If rates fall, your payment will decrease. Your payment is adjusted.
The pro to this type of mortgage product is that your amortization period will remain the same. You will always be making the same payment towards the principal, it’s just the interest portion that will change.
Cons of an Adjustable Rate Mortgage
When you hear the media talking about people not being able to afford their mortgage payments because of rate increases, it could be because they are in an adjustable-rate mortgage vs. a variable-rate mortgage.
For example, a rise of .75% on a $350,000 mortgage is $94 a month. There’s only so much budgeting you can do to manage that type of increase, especially after the increases we've had this year.
What Should You Look for When Choosing Between a Fixed and Variable Rate Mortgage?
Just keep in mind that no one can predict where rates are going to be with any certainty.
No one was prepared for the type of chaos over the last few years, interest rates or otherwise.
Also, none of the economists who make the predictions will be making your mortgage payments so you have to understand what works for your budget.
Payment Frequency – Make sure you are aware of the options available before deciding. Some lenders may not allow certain variations of payment frequency.
Prepayment Options – Prepayment options are a great way to pay down the principal of your mortgage faster, but some lenders will limit how much you’re allowed to put down each year.
Penalties – Do you think you’re going to break your mortgage before 3 or 5 years? A variable-rate mortgage typically has a penalty of three months of interest. Fixed-rate mortgages may have higher payment penalties determined by using a complicated formula called Interest Rate Differential.
Conversion to Fixed Rate – If you stay with the same lender, you should be able to switch from a variable rate to a fixed-rate mortgage with no penalty, however, the rate you pay may change.
So, Which Type of Rate Do You Choose?
Remember, there’s so much more than interest rate.
Look, I know mortgage rates are important, but people spend too much time trying to find the lowest rate.
With rates on the rise, the type of mortgage you qualify for comes down to what you can afford on a monthly basis.
So, if you want to discuss your options and figure out what that monthly payment looks like between a variable rate or fixed rate mortgage, give me a call.
I’m happy to help.