Choosing Between Variable and Fixed Mortgage Rates in Canada

Making the Right Decision for Your Home Loan

Buying a home is one of the most significant financial decisions in a person's life. For most Canadians, obtaining a mortgage is essential to make this dream a reality. One of the crucial choices borrowers face when applying for a mortgage, renewing, or refinancing is deciding between a variable and fixed mortgage rate. Each option comes with its advantages and disadvantages, and understanding the key differences can help borrowers make an informed decision tailored to their financial circumstances and risk tolerance.

In this article, we will delve into the intricacies of variable and fixed mortgage rates in Canada, offering a comprehensive comparison to assist you in choosing the most suitable option for your unique needs.

Understanding Mortgage Rates in Canada

Before we delve into the nuances of variable and fixed mortgage rates, it's essential to grasp the fundamentals of how interest rates are determined in Canada. Mortgage rates are influenced by various factors, including the Bank of Canada's policy rate, inflation, economic indicators, and global financial trends. Additionally, lenders will consider your creditworthiness, down payment, and the length of the mortgage when determining your interest rate.

Fixed Mortgage Rate

A fixed mortgage rate is one where the interest rate remains constant throughout the entire mortgage term, regardless of fluctuations in the broader economic environment. Here are the key features of a fixed mortgage rate:

Advantages of Fixed Mortgage Rates

• Certainty and Predictability: One of the most significant advantages of a fixed-rate mortgage is its stability. Borrowers know precisely how much they will pay in interest each month, making it easier to budget and plan for the future.

• Protection Against Rate Increases: With a fixed rate, you are shielded from sudden interest rate hikes, which can provide peace of mind, particularly in times of economic uncertainty.

• Risk Protection: Fixed-rate mortgages are ideal for risk-averse individuals who prefer to avoid financial uncertainty and want to lock in a consistent monthly payment.

Disadvantages of Fixed Mortgage Rates

• Potentially Higher Rates: Fixed rates often come at a slightly higher initial interest rate compared to variable rates, as lenders incorporate an “insurance” premium to compensate for potential rate increases in the future.

• Limited Flexibility: Fixed mortgages may have higher fees for breaking the contract. If you want to move your mortgage or pay it off before the term is complete. This makes it costly to refinance or make changes to your mortgage prematurely.

Variable Mortgage Rate

A variable mortgage rate, also known as an adjustable or floating rate, is tied to the lender's prime rate or the Bank of Canada's policy rate. As these rates fluctuate, the interest rate on the variable mortgage will also change. Here are the key features of a variable mortgage rate.

For a variable rate (VRM), the monthly payment stays the same for the full term regardless of changes to the mortgage rate. With an adjustable-rate mortgage (ARM), your monthly payment will fluctuate.

Typically, lenders will call both VRM and ARM a variable rate when referring to them, which can be a little confusing.

Advantages of Variable Mortgage Rates

• Potential for Savings: In periods of declining interest rates, borrowers with variable rates can benefit from lower monthly payments and overall interest costs. Typically, rates fall during an economic slowdown, so a variable rate could be advantageous if most economists forecast a recession. Remember that forecasts are speculative, and the outcomes are not guaranteed.
  For ARMs, drops in interest rates can lead to a drop in monthly payments, leaving you with more spending money.
  For VRMs, drops in interest rates can lead to changes in how much the balance of the mortgage is reduced. As rates drop, less of your monthly payment is allocated to interest, and more remains to pay down the loan. As a result, you might repay your mortgage faster than planned, or your monthly payments might go down at renewal because you are ahead of schedule on your repayment.

• Flexibility: Variable mortgages often offer more flexibility regarding early repayment (prepayment) options and penalties for breaking the mortgage early.

• Lower Rate: Generally, variable rates are lower than fixed rates at any point in time, which can be attractive to borrowers looking to save on monthly payments initially.

Disadvantages of Variable Mortgage Rates

• Uncertainty: The main drawback of a variable rate is the uncertainty it brings.
  For ARMs, increases in interest rates can lead to increases in monthly payments, making it harder to budget and plan.
  For VRMs, increases in interest rates can lead to a drop in how much the balance of the mortgage is reduced. As rates rise, more of your monthly payment is allocated to interest, and less remains to pay down the loan. As a result, it might take longer to repay your mortgage, or your monthly payments might go up at renewal because you are behind on your repayment.

Considerations for Choosing Between Variable and Fixed Rates

Economic Conditions

Analysing the current economic conditions and forecasts can provide insights into potential interest rate movements. If the economic outlook suggests stable or declining rates, a variable rate may be more appealing. Conversely, if rates are projected to rise, a fixed rate might offer more security.

Risk Appetite

It’s impossible to eliminate all risks, but it is important to understand which risks are most troubling for you. Consider your ability to withstand fluctuations in interest rates. If you can comfortably handle potential rate increases in the 2 to 6 per cent range, a variable rate may be suitable. However, if an increase of one or two per cent would present a financial challenge and you prefer financial stability and predictability, a fixed rate may be the better choice.

Time Horizon

Assess your future plans and how long you intend to keep the mortgage. If you plan to sell the property or refinance within a short time frame, a variable rate might be a viable option. On the other hand, if you plan to stay in your home for an extended period, a fixed rate can provide stability.

Flexibility Requirements

If you anticipate changes in your situation, such as the possibility of early repayment or refinancing, needing to move for work, or a new addition to your family, a variable rate mortgage's greater flexibility might be advantageous.

Conclusion

Choosing between a variable and fixed mortgage rate in Canada is a decision that should be based on careful consideration of:

• Mortgage rates

• Mortgage up-front and back-end fees

• Expected future mortgage rates

• Your financial situation

• Your risk appetite

• Your flexibility needs for future mobility

Each option comes with its own set of benefits and drawbacks, there is no one-size-fits-all approach, and your decision today might be different from your decision in three, or even five years.

By understanding the differences between different variable rate products and different fixed rate offerings, you can make an informed decision that aligns with your needs and objectives.

Remember to consult with mortgage professionals or financial advisors to gain personalised insights and ensure you make the best choice for your unique circumstances.

For most Canadians, their home is their largest investment and their mortgage is their largest debt, so selecting the right mortgage product has a significant impact on their future financial wellbeing. We hope this article will help you have a more successful homeownership journey.