The recent interest rate hike by the Bank of Canada could have new homeowners questioning the advantages of fixed rate mortgages versus variable rate mortgages. Each has its pros and cons, depending on your financial goals and tolerance for risk. Here’s the difference between a fixed rate and variable rate mortgage and how to determine which is right for you.
What is a fixed rate mortgage?
A fixed rate mortgage is a loan with an interest rate that remains the same over the term of a mortgage, which is usually three to five years. As the name implies, a fixed rate mortgage will not change and offers predictability in payments from month-to-month. Borrowers that want reassurance over their repayment timeline may appreciate the stability of a fixed rate mortgage, especially if there is an important financial milestone they are working towards, such as retirement, within the term of the loan. Open fixed rate mortgages allow borrowers to pay off the remainder of their loan at any time while those with closed fixed rate mortgages could incur penalties when paying off their mortgages early.
What is a variable rate mortgage?
The interest rate for a variable rate mortgage will fluctuate over the term of the mortgage, tied to the bank’s prime rate, which is based on the interest rate set by the Bank of Canada. An increase in interest rates could mean that more of your mortgage payment goes towards interest, extending the timeline for paying off your mortgage, or that you will have a higher monthly mortgage payment. Likewise, you’ll benefit from a decrease in interest rates when more of your payment goes towards reducing the principal or will pay less for your mortgage per month. Those with variable rate mortgages may convert to a fixed rate mortgage at any time.
Which mortgage is right for me?
Historically speaking, variable rate mortgages have performed better than fixed rate mortgages. Research from the Bank of Montreal shows that over the life of a mortgage, a variable rate mortgages have been cheaper 83 percent of the time. If past history is an accurate guide, this means that you will more than likely pay off a variable rate mortgage faster than a fixed rate mortgage. However, those seeking variable rate mortgages should feel comfortable with the possibility of fluctuating interest rates and have flexibility in their budget and timeline to cover potential increases.