As a Canadian home buyer or mortgage shopper, one of the first decisions you’ll face is whether to choose a fixed-rate or variable-rate mortgage. While both offer their pros and cons, understanding how they work and what they provide borrowers may help you narrow down which one is best suited for you. There are many factors to consider including your personal finances, your level of risk tolerance and even the current economic situation. Read on to learn more about fixed-rate and variable-rate mortgages so you’re ready to make a decision when the time comes.
What Is A Fixed-Rate Mortgage?
About 72% of all the mortgages in Canada are fixed-rate, according to Mortgage Professionals Canada. A fixed-rate mortgage means the rate you get when you first sign stays the same throughout your whole term. The downside with this type of mortgage is that the bank is taking a chance lending you money over a long period of time at a fixed-rate, so they need to factor the risk and opportunity cost into the rate they offer you. To compensate for rates potentially going up during your term, they’ll charge you a slightly higher fixed interest rate to account for it. This option lets you move forward worry-free so you can sleep peacefully at night knowing your rate is locked in.
It’s important to note that choosing a fixed-rate mortgage is definitely still a risk as you’re betting that you won’t need to sell or refinance during your term. Most banks’ penalties on breaking a fixed-rate mortgage are usually quite high so be sure to take that into consideration when you make your choice. It’s more common than you think for people to break their mortgage term.
What Is A Variable-Rate Mortgage?
The bank assesses their overnight rate eight times each year and as a result, their prime rates change. Having a variable-rate mortgage means that each time the bank does this, there’s a chance your interest rate will change over the course of your mortgage term (typically 3 – -5 years).
The benefit is that you’ll likely save right from the start with a lower interest rate and you’ll have the luxury of choice with fewer penalties for breaking your mortgage agreement. If you can live with some uncertainty, you desire the flexibility and are focused on saving more money upfront, a variable-rate mortgage may be the best option for you.
Comparing Fixed-Rate And Variable-Rate Mortgages
When comparing fixed and variable-rate mortgages, there are a few things you’ll want to consider:
Benefits Of Fixed-Rate Mortgages
– They make it easier to create a budget as the cost is fixed every month
– You’ll have a sense of security as you’ll know what to expect over your term
– The interest charge is reduced as you pay down the principal
If you’re on a pretty tight budget and have a hard time dealing with unexpected expenses, a fixed-rate mortgage may be the best choice for you to ensure that you and your family don’t need to endure any financial hardship throughout your term.
Benefits Of Variable-Rate Mortgages
– Your interest rate will likely be lower than with a fixed-rate mortgage
– They tend to be less expensive over the term of the loan
– If you’re looking to secure a larger loan, an initial lower payment may help
Choosing a variable-rate mortgage means more flexibility, but it also means less security as you’re essentially at the mercy of the prime rate throughout your term. You could end up saving a significant amount of money over time, but you take the chance that the rates may go up which in turn, could increase your monthly payments considerably. If your expendable income can fluctuate and you’re not worried about sticking to a specific payment every month, you may prefer taking the risk on a variable-rate mortgage.
With a variable-rate mortgage, you’ll also have the option to lock in to a fixed-rate at any given time during your term, but you’ll need to work with your lender to determine if that makes financial sense. Keep in mind that in Canada, it’s quite common to choose a mortgage term that lasts anywhere from a few months to 5 years, so you can always change your mind at the end of your term and make a switch to a better-suited option if your original choice didn’t pan out as expected.
What To Do As Interest Rates Change
Keeping an eye on interest rates means as soon as you notice an increase, you can ask yourself “how will this impact my mortgage payments?” Interest rate increases can have an immediate impact on your monthly payments if you have a variable-rate mortgage or an upcoming renewal. You can consider these options if rising interest rates become an issue:
– You may want to ask your lender about an interest rate cap. This is the maximum interest rate your lender can charge on your mortgage so even if rates increase, you know you won’t have to pay more than this cap.
– If more increases are expected, consider converting your variable-rate mortgage to a fixed-rate mortgage so you can work toward stabilizing your monthly payments.
– If you don’t want to lose your variable-rate mortgage, consider making accelerated payments in one lump sum or period payments when rates are low. This way you can adjust your budget based on possible future interest rate hikes.
When it comes to applying for a mortgage in Canada, you have a few different options, but understanding how they differ is crucial to ensuring you choose the right one for your personal situation. Whether you’re on the hunt for a new home or your current mortgage term is coming up for renewal, taking the time to learn more about your mortgage options means you won’t get caught off guard when the time comes to make a big decision. If you’re looking to speak with a professional for some guidance or industry insight, reach out to our team at Rocket Mortgage™!