Fixed vs variable mortgage; choosing a winner can be daunting for most Canadians looking to buy a home. But at the end of the day, both types of mortgage rates have their pros and cons.
In this article, we’ll compare fixed and variable rate mortgages. Then you can know exactly which type of mortgage is better for you and your family.
Table of Contents
Fixed vs Variable Mortgage Rates: Which is Better?
“Better” means different things to different people. In other words, while the benefits of a fixed rate mortgage may be enjoyed by some, a variable rate mortgage may be the wiser choice for others.
Ultimately, the best choice for you and your family depends on first knowing your goals, and then adjusting your expectations. Once you do that, you can determine your risk tolerance and find out which type of mortgage is the best choice.
That means before we compare fixed and variable rate mortgages, you first need to take the time to ask yourself these important questions. Trust us, this will make understanding your best options much easier.
…And with that said, let’s get into it!
Questions You Need to Ask Before You Decide on a Mortgage
1. Know Your Goals
Conveniently, most Canadian mortgages are broken into five year terms. This makes it much more tangible to set your goals.
The main thing you’ll want to focus on in this step are the financial goals for you and your family. Where do you want to be when you renew your next mortgage term?
Please note, if your term is set for five years, plan your goals around five years. If it’s for 10 years, plan for 10 years.
Key Questions:
- Do I plan to sell the house in the next 5 years?
- How much debt will I be able to repay?
- Will I be having children?
- Will my children be starting school or university?
2. Adjust Your Expectations
Now that you have your financial goals, you need to take a hard look at your current environment. That means everything from the economy at large, to your health prospects.
For example, is there a health condition in your family that could become a problem down the line? Are you hearing a lot about a recession in the news?
Essentially, this step is about understanding how much uncertainty there is between you and the goals you set in the first step.
Key Questions:
- What is the inflation rate right now?
- Can I qualify for my bank’s prime rate?
- Do any health issues run in my family?
- Do I expect to take on any major expenses in the new few upcoming years?
3. Determine Your Risk Tolerance
Now that you know the potential barriers between you and your goals, think about how likely you are to overcome that uncertainty.
Let’s go back to the example mentioned earlier. Perhaps the health issue in your family is unlikely to affect you until you are much older, or maybe you have insurance protection.
In short, the point of this step is to give you a better idea on the chance you will overcome financial uncertainty.
Key Questions:
- Does my family depend on a sole-income provider?
- How seriously has my career been affected by past recessions?
- Do I have financial protection in place?
- How stable is my household income?
So now that you’ve assessed your current situation, let’s compare the two main types of mortgage rates in Canada…
Comparison Chart: Fixed vs Variable Mortgage
Use this chart to better understand the differences between fixed and variable mortgage rates.
| Fixed Rate Mortgage | Variable Rate Mortgage | |
|---|---|---|
What are they? | A fixed rate means your mortgage payment will not change for the duration of the term. Therefore only when you renew your term, could your monthly payments change. Keep in mind, your mortgage interest rate will be more money since banks can’t raise your rate, and need to plan for uncertainty. | A variable rate means either; what you pay may go up during the mortgage term, or your rate stays the same but you’re paying interest more than principal. These interest rates rise and fall when your bank’s prime rate adjusts with the central bank rate. |
Which is Best for a Low or High Risk Tolerance? | Low: Fixed rate mortgages are less risky because your interest rate and payment stay the same for the entire term. That means mortgage holders don’t ever have to worry about a sudden hike in their current mortgage rates. | High: Variable rate mortgages are more risky as your interest rates rise and fall with the Bank of Canada’s key interest rate. This either effects your payments, or the time it takes to pay your mortgage. |
Which has Smaller Monthly Payments? | Fixed rate mortgages may need more interest payments made overall. Since your mortgage lender cannot increase your rate for the mortgage term, your initial interest rate needs to include a small buffer. This may mean a slightly higher monthly payment. | Variable rates offer the potential for lower payments if the Bank of Canada drops their key policy rate. Furthermore, since mortgage lenders are able to adjust your rate as needed, they don’t need to increase your rate for uncertainty. |
Which Cost Less in Total? | More money tends to go into fixed rates. Your mortgage broker will need to charge a little bit higher interest rates since they can’t increase your rate. Even though a fixed rate is secured by stable bond yields, financial institutions need to account for that tiny bit of uncertainty. | Many studies have found variable rate mortgages tend to cost less overall, even during times when interest rates rise. Of course, these studies rarely go back earlier than the 1950's, and that may not be enough certainty for some people. |
Which is More Popular Among Canadians? | The vast majority of Canadians go for fixed rates. In 2016, it was found that 74% of homeowners had fixed mortgage rates. | With only a little over a quarter of Canadians preferring a variable rate mortgage, they are clearly less popular despite their historical value of having lower interest rates. |
What Factors Influence this Type of Mortgage? | Bond yields are the main thing to determine your monthly mortgage payments. Bonds are secured by governments, and issued in terms. That makes them a very safe and stable way for banks to secure your mortgage term. | Your bank’s prime lending rate is used to determine these mortgages. Prime rates can potentially increase if the Bank of Canada increases their key interest rate. That means, your monthly payments can go up and down. |
| Fixed Rate Mortgage | Variable Rate Mortgage | |
|---|---|---|
What Gets You a Better Mortgage Rate? | Shop around! If you don’t know where to start, find a mortgage broker. That's because they’ll shop around for you to find you the best interest rate possible from a financial institution. | You can get a better rate with your variable mortgage when you have good credit with your bank. The lowest interest rate major banks will give you is their prime lending rate which is the baseline for variable rate mortgages. |
What Gets You a Worse Rate? | Fixed rate mortgages are influenced by the Canadian economy more generally. That’s because your financial institution secures them with bond yields. When the Canadian economy struggles, fixed rates will eventually be affected. | When the Bank of Canada raises their key policy rate, major banks have to raise their prime lending rates. In addition to when interest rates increase, having bad credit with your bank will also impact your variable rate mortgage. |
What Happens if You Need to Move or Cancel? | Most banks will charge you the interest rate differential, i.e. the difference between the interest rate at the start of your term, and the interest rate at the time of cancelling. It usually doesn’t matter whether you are moving to a new house or cancelling for another reason. | A variable rate mortgage is much easier to break. You may be charged extra fees, but they won’t be as much as canceling with a fixed rate. Often the penalty is only a few months worth of interest payments. |
| Fixed Rate Mortgage | Variable Rate Mortgage | |
|---|---|---|
How Can You Pay Your Mortgage Faster? | Fixed mortgage rates are often just that, fixed. However, many Canadian banks allow you to increase your payments up to a certain percentage. Talk to your bank to find out if that's an option. Make sure you also ask about hidden fees and penalties before you pay it off! | Being able to pay a variable mortgage faster than the term can sometimes be arranged in the mortgage contract. However like a fixed rate, you may end up with hidden fees and penalties. With that said, these charges are still often less than with a fixed rate. |
Can I Switch to the Other Type? | No, You cannot switch a fixed rate mortgage into a variable rate. | Yes, most mortgage lenders allow you to switch your variable rate to a fixed rate at anytime. However, banks don't always guaranteed it. That means you need to talk to your bank if you are interested in having this option. |
Fixed vs Variable Mortgage Summary
A fixed rate mortgage is better for people that want stability. That’s because your mortgage rates stay the same for the whole term. However, that comes at the expense of not getting the lowest interest rate possible. Moreover, you may receive extra charges if you need to cancel.
Variable rate mortgages have historically cost less money overall, but your rates may rise and fall throughout the duration of the term. With that said, you may have the option to switch to a fixed rate at anytime.
Key Takeaways
- When comparing fixed vs variable mortgage rates, know both have pros and cons
- To make the best decision, you need to know your goals and set reasonable expectations
- Payments with a fixed rate mortgage stay the same for the entire duration of your mortgage term
- Payments with a variable rate mortgage go up and down during the term
- Canada’s bond yields influence mortgages with fixed rates
- A major bank’s prime rate affects variable rate mortgages
- The Bank of Canada’s key policy rate dictates your bank’s prime rate
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