Fixed vs Variable Mortgage: What’s the difference?

Buying a home is one of the biggest financial decisions in many of our lives. Rather than paying fully in cash, most homebuyers will choose to borrow money from the bank to pay for their home. In today’s competitive housing market, understanding how mortgages work is extremely important for those who are looking to buy a property. The debate between getting a fixed vs variable mortgage can go on for hours, so it’s best you understand how they both work, so you can make an informed decision.

What is a fixed rate mortgage?

As the name suggests, a fixed rate mortgage rate is one that does not change over the length of your mortgage term. Under a fixed rate, you would be paying the same amount in monthly mortgage payments regardless of changes to interest rates, which usually follow the Bank of Canada’s prime rates. Typically, rates are fixed for a set period of time. While mortgage amortization periods are usually 25 years, you usually have to renew your mortgage every 5 or so years. This means that the fixed rate is only guaranteed until your next mortgage renewal.

The benefit of a fixed rate mortgage over a variable mortgage is that you will have a defined period of time where your monthly payments would not change. This predictability makes planning finances and budgeting easier. A fixed rate will be slightly higher than the variable rate, as you are paying for the predictability that comes with this option.

What is a variable mortgage?

A variable mortgage follows many of the same rules as fixed mortgages. The major difference between the two is the fact that the rate of interest you are paying as a borrower can change over the course of your mortgage rate period. This means that the monthly payments can either go up, down, or stay the same. In general, a variable mortgage begins at a lower rate than a fixed mortgage. As mentioned before, those who pick fixed mortgages are paying a premium for the security.

Variable mortgages are adjustable rates. This means that they can go up or down depending on the prime rate. Now, keep in mind that there are interest rate caps, or maximums, in place. However, small changes to the prime rate can still add thousands of dollars to your payments over the years, so understanding the risks and benefits associated with variable mortgages is important before making any decisions.

Should I get a fixed or variable mortgage?

This is a difficult question to answer, as there are many factors that homeowners need to consider when making this decision. One of which is where you believe the economy will be going and the role that it will play on the fluctuations of interest rates. If you think prime rates are going up, it is beneficial to lock in a lower rate through the fixed-rate option. If you think prime rates will be going down, then you do not want to be locked in at a higher rate, which means that the flexibility of the variable option would be more appealing.

Choosing between a fixed rate  mortgage or variable rate mortgage can also depend on your goals. For example, if the home you want to purchase is just a starter home and you don’t plan on spending too long there, then it might be worth it to go with a variable mortgage, assuming the initial interest rate is on the low side. However, if this is your dream home and you plan on staying long term, then it might be safer to do a fixed rate mortgage. 

Your personal financial circumstances as a homeowner will also play a role. If you have a tight monthly budget that knowing that your mortgage interest rate will stay the same over the loan term can provide some stability and peace of mind. Plus, it makes it easier to budget and help avoid any potential stress about future mortgage payments.

Fixed rate vs variable rate pros and cons

There is no right or wrong answer when it comes to choosing between fixed rate vs variable rate mortgage loans. As mentioned above, it really depends on the economy, your life goals, and your current financial circumstances. Here’s a quick summary and breakdown of the main pros and cons to help you decide which route to go with your mortgage lender.

Fixed rate mortgages 

Pros: 

• “set it and forget it”
• Makes it easier to budget 
• Offers stability and eases anxiety 

Cons:

• You pay a premium for the stability offered by fixed rates
• Can end up costing you more over the fixed period depending on the current rates on offer

Variable rate mortgages

Pros: 

• Can result in lower interest payments over time. Historically speaking, variable interest rates have proven to be beneficial to many homeowners.

Cons:

• Financial uncertainty can increase your financial burden
• Can just as easily lead to paying more in interest as it can to paying less in interest

As you make your decision you can also play around with mortgage calculators. Your mortgage lender or even financial advisor can help you with this. Or you can easily find free ones online. 

What affects mortgage rates?

As briefly mentioned, mortgage rates offered by lenders such as financial institutions are correlated with the Bank of Canada’s current prime rates. These prime rates are the bank’s way of setting monetary policy and guiding the economy. In general, economic booms may result in increases to prime rates, while economic downturns may result in decreases to prime rates.

Aside from prime rates set by the Bank of Canada, personal circumstances like credit score and employment history will also impact the mortgage rate you are eligible for. A strong financial position will help you, as a homeowner, get lower interest rates.

Where to get a mortgage?

Regardless of whether you go fixed vs. variable mortgage, there are several ways to access mortgage services. One of the most common is to work with a mortgage broker. These brokers are specially trained to work with several different lenders to get the best rates for their clients. Brokers will “shop around” to different financial institutions and/or private lenders in order to find the lowest rates. This service is valuable to home buyers as it both saves time and also allows them to gain access to lenders that may not directly work with the public. Brokers often have built relationships over time and are able to access rates that you would not be able to find as an individual. Best of all, mortgage brokers are a free service, as their commissions are paid by the lender who will eventually get your mortgage.

If a buyer chooses to not work with a broker, they can also go to mortgage specialists at financial institutions. Some buyers may have established relationships at their bank and want to go this route. However, the downside of this approach is that you may not be able to get the lowest rates due to a lack of available options.