If you’ve begun looking into your home financing options, you’re likely wondering the difference between a fixed vs. variable mortgage rate. That’s because these are the two most common types of home loans offered in Canada. By understanding the pros and cons of each, you can weigh up your options and choose a mortgage type and term that makes the most sense for you financially.
A fixed-rate mortgage means that the amount of interest you pay on your loan remains the same for a set amount of time (the mortgage term), which, in Canada, is usually between one and five years. With a fixed-rate mortgage you lock in your rate for the term of the loan, so you know how much you will be paying each month.
A variable-rate mortgage means that the amount of interest you pay on your loan will change based on economic conditions. So if the Bank of Canada puts interest rates up, then more of your payment will go toward covering interest and your monthly payments could increase if it does not cover the increased rate on your borrowings. If interest rates go down, then more of your payment will go toward the principal. As a result, a variable-rate mortgage is more of a gamble, but if economic conditions work in your favour and you’re comfortable with taking the risk, it can mean you pay less interest over the life of your loan.
The main reason many homebuyers opt for a fixed-rate mortgage over a variable rate is the stable interest rate, which remains constant throughout the term of the loan. This means that you know exactly how much you’ll pay each month, making it easier to budget and plan your finances.
With the rate security of a fixed-rate mortgage you are protected against any interest rate fluctuations. This means that you can rest assured that even if interest rates go up, your payments will remain the same for the term of the loan. If you’re looking for stability in your monthly payments and you don’t want to have to worry about how market conditions may impact the cost of your loan, then a fixed-rate mortgage could be your best bet.
The main con of a fixed-rate mortgage is that the rate you pay will be the same for better—or worse. So even if economic conditions improve and interest rates come down, you still pay the same amount of interest, which could mean the average cost of your loan is higher than if you’d gone with a variable rate.
Fixed-rate mortgages always lock in your rate for the term of your loan, but they can be open or closed. The difference is that an open fixed-rate mortgage can be paid off at any time and without any fee. However a closed fixed-rate mortgage can be costly to get out of if your circumstances change or you decide to sell before the loan term is up. That’s because with fixed-rate mortgages the lender is taking the risk that if rates go up they can still only charge you the same fixed rate. As a result, your mortgage lender may include a prepayment penalty in your loan contract, which is a fee that you could be charged if you pay off your loan before the loan term is up, including if you sell.
Breaking your closed fixed-rate mortgage contract early can cost thousands of dollars in fees, so you should always confirm with your lender at the outset how much they would be. In most cases it will be dependent on how much you want to pay off, how many months are left in the mortgage term and interest rates. The lender will usually charge the higher fee of either the amount equal to three months’ interest on what you still owe, or the interest rate differential (between what you’re paying and current rates).
With a variable-rate mortgage, the lender will offer you a prime rate, which you’ll pay each month, but the portion of your payments that go toward interest or your principal will vary and be dependent on interest rates. Since you are taking on more risk than the lender, the variable rate may be lower than if you go fixed. Homebuyers will often choose the variable option if they have a higher risk tolerance and are drawn to the potential cost savings over the course of the loan term.
When the economy is stable or if it improves, a variable rate works in your favour and may bring down the overall cost of your loan.
Many variable-rate mortgages offer flexible terms so that if interest rates come down you can lock in that rate by switching to a fixed-rate mortgage at any time and without any penalty or fee. This might be a preferable option if the economy is showing stability or if rates are high and you think they might come down before the typical three- or five- year fixed-rate mortgage term.
When you choose a variable vs. a fixed rate mortgage, the rate you pay is going to vary with economic conditions. The Bank of Canada sets and determines interest rates based on the economy and inflation. When inflation is too high, that is bad for the economy, and the Bank will raise interest rates to encourage people to spend less money, save more and cool demand in the economy.
When interest rates are high, it costs people more to borrow money, which means they will be less likely to make big investments, like a home or a car. High interest rates also increase the incentive to save money and so this encourages people to save what they have and further dampen economic growth.
In other words, if the economy is doing well then you’re going to pay less, but if the economy is doing badly then you are going to pay more. This is far more risky for a buyer and means you have to be comfortable with potential fluctuations.
Since the rate you pay on a variable mortgage will change based on economic factors beyond your control, your choice over whether to choose a fixed- or a variable- rate mortgage ultimately comes down to your risk tolerance. While you can assess current market conditions and make informed predictions about where it may be going, no one can know for certain. There can always be rate fluctuations, so you have to weigh up the risk and potential reward, as well as align your choice with your long-term financial goals and personal preferences.
You should also factor in how long you intend to live in a home because breaking or paying off a closed fixed-rate mortgage before the loan term ends can be very costly.
If you’re looking for stability and predictability, a fixed-rate mortgage is likely your best choice. But if you feel confident about where the market is going and you have the ability financially to cover any future rate fluctuations, then a variable rate may be more affordable over the loan term.
No matter whether you opt for a fixed or a variable rate mortgage, it’s good practice to regularly monitor and review your mortgage terms, especially as economic conditions change.
With most variable-rate mortgages you can change to a fixed-rate at any time and lock in the rate if it comes down to a number that works with your budget. This scenario will be more likely if you’ve bought your home when interest rates were high and so you’ve decided on a variable-rate mortgage in the hopes that the rates will come down before you lock in a fixed rate. Or if you’ve bought when the economy is showing stability and so the lower variable rate of a stable economy is more appealing, but you want to lock in a fixed rate before you anticipate interest rates rising again.
Fixed-rate mortgages can be more complicated and costly to change, but you can always talk to your lender about refinancing or renegotiating the mortgage terms if needed.
Being a homeowner doesn’t mean you have to be a do-it-aloner. Houseful is here to introduce you to experts who don’t just know their stuff, they know you too. Get matched with a real estate agent in your area for local insights and connect with an RBC mortgage advisor for financing guidance. Visit houseful.ca.
This article offers general information only and is not intended as legal, financial or other professional advice. A professional advisor should be consulted regarding your specific situation. While the information presented is believed to be factual and current, its accuracy is not guaranteed and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the author(s) as of the date of publication and are subject to change. No endorsement of any third parties or their advice, opinions, information, products or services is expressly given or implied by Royal Bank of Canada or its affiliates.
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