Buying a new home is a big accomplishment. It’s also a process full of decisions.
The type of mortgage you select can have a major impact on the cost of owning a home. That means it’s always good to understand your options. Choosing between a variable-rate mortgage and a fixed-rate mortgage is a great place to start.
Let’s take a closer look at variable-rate mortgages in Canada. We’ll compare them with fixed-rate mortgages, discuss their pros and cons, and more.
What is a Variable-Rate Mortgage?
How do variable mortgage rates work? The prime interest rate used by a lender influences the interest charged on a variable-rate mortgage. The prime interest rate itself can change over the loan term, based on a variety of economic conditions.
Variable interest rate mortgages often (but not always) include a discount set in relation to the prime interest rate. That’s one of the key factors that make them attractive to homebuyers. In the right economic conditions, a variable mortgage can lead to some serious savings.
When the prime interest rate is low, variable-rate mortgages can offer a greater value than other options. However, when the prime interest rate is high, a variable-rate mortgage can be more expensive than the alternatives.
Variable-Rate Mortgages and Fixed-Rate Mortgages
This means external factors (i.e. national and international economic conditions) influence variable-rate mortgages. That’s the most important difference when comparing them to fixed-rate mortgages.
As their name implies, fixed-rate mortgages have a set interest rate. It does not change over the life of the loan. That makes payments more predictable over time.
How Do Variable-Rate Mortgages Work?
Variable-rate mortgages are like fixed-rate mortgages in the big picture. However, there are some key differences.
The Bank of Canada explains that variable-rate mortgages have two types of payment structures. How does a variable mortgage work when it comes to payments?
Variable payments change along with the prime rate. Payments will increase or decrease in step with the prime interest rate to address changes in interest owed.
Fixed payments stay the same each month, despite changes in the prime interest rate. However, the amount of money that goes toward interest and principal will change.
That means it takes longer to pay off the principal of the loan, and ultimately costs borrowers more money. Even with fixed payments, the monthly payment can increase with rising interest rates. If interest rates reach the “trigger rate,” mortgage payments may need to increase.
What’s Better: A Fixed-Rate Mortgage or a Variable-Rate Mortgage?
There’s no simple answer to the question of whether a fixed-rate or variable-rate home loan is “better.”
Fixed-rate mortgages offer predictability and consistency. You always know what you’ll pay, thanks to the fixed interest rate.
Variable-rate loans offer opportunity combined with potential risk. Depending on large-scale economic factors, you could see your interest rate rise or fall.
For this reason, it’s very difficult to make a direct value comparison between fixed and adjustable-rate mortgages. Instead, it’s better to think about it in terms of your appetite for risk and plans for the future.
Do you believe that interest rates will stay low over the term of your mortgage? A variable-rate mortgage could save you money. Yet, because no one can guarantee the future, there’s always an element of risk involved. Taking out a variable-rate mortgage at the wrong time can lead to higher payments over the long term.
A few more benefits to consider:
- It’s less expensive to break a variable-rate mortgage than a fixed home loan.
- Many variable-rate mortgages offer the opportunity to convert to a fixed-rate mortgage. If things don’t go as planned, you could convert for more stability.
If you value consistency and the monthly payments seem reasonable, a fixed-rate mortgage can be a good choice. You won’t benefit from decreases in interest rates. However, you won’t have to worry about increases, either. Fixed mortgages represent a steady, predictable path forward.
One thing to keep in mind about a fixed mortgage is the high cost of breaking the contract. Want to buy a new home or want to refinance and have a closed, fixed-rate mortgage during its term? The decision will cost you.
Finding a Mortgage Lender You Can Depend On
Working with a supportive, informative, and trustworthy lender makes choosing the right mortgage that much easier.
We’d love to help you find the best mortgage for your needs. With self-service tools like our mortgage finder and knowledgeable, supportive staff, we can help you make an informed decision.