Should I choose a fixed-rate or variable-rate mortgage?

What’s a fixed-rate mortgage? 

The name says it all. A fixed-rate mortgage stays the same throughout the entire term of your loan. Your term is the length of your mortgage contract. It can vary from anywhere between a few months to 10 years.  

Generally, fixed-rate mortgages may have higher rates than variable-rate mortgages, but are a better option if: 

Interest rates are notably low now, and you want to secure your rate and avoid any potential future increases.  

You’d rather budget for predictable and consistent payments, generally with the same principal-to-interest ratio, regardless of market fluctuations. 

What’s a variable-rate mortgage 

A variable-rate mortgage fluctuates depending on the prime rate of your financial institution. The prime rates vary mainly according to the key interest rate issued by the Bank of Canada. Variable-rate mortgages are adjusted each month to reflect these fluctuations. It’s an interesting choice if: 

• You want to take advantage of a lower rate from the start and potential rate decreases during your term. 
• Your budget can handle an increase in your monthly payments or a reduction in the principal repaid in the event of rate increases. 

Capped variable rate 

A capped variable rate will fluctuate depending on the market but will never exceed a threshold established when you take out a mortgage. This option allows you to take advantage of rate decreases while protecting you from rate increases. You should note that there is usually an additional premium to pay for this type of rate. 

Fixed payments with a variable-rate mortgage 

Certain financial institutions will offer fixed monthly payments with a variable-rate mortgage. How does this work? If your interest rate decreases, you'll pay more principal and less interest, and vice versa if it increases. When rates reach a certain percentage, your financial institution will contact you to adjust your mortgage payments. 

Are fixed payments and variable rates the best of both worlds? 

Not necessarily. Even if you have fixed payments, rate fluctuations will have an impact when you need to renew your mortgage. You may have to increase your monthly payments to keep the same amortization period. Or you'll have to refinance your mortgage and extend your amortization to keep your lower payments. 

Variable-rate mortgages are often the best choice 

According to many economic experts, in most cases variable-rate mortgages are more beneficial in the long-term compared to fixed-rate mortgages.  

That being said, keep in mind that the most advantageous option for you will depend on the economic situation, your personal finances and risk tolerance. Like all financial products, each case is unique.  

What’s a hybrid or made-to-measure mortgage? 

A hybrid or made-to-measure mortgage combines both a fixed-rate and variable-rate mortgage into one. The idea is simple: Divide your mortgage into segments. Each of these segments have their own characteristics, including term, interest rate, etc. That way, you’ll be able to get the advantages of a variable-rate mortgage for a part of your loan, and secure another part with the advantages of a fixed-rate mortgage.  

What causes mortgage rates to change? 

Variable mortgages rates 

As mentioned earlier, a variable mortgage rates fluctuates depending on the prime rate of your financial institution. Prime rates vary mainly according to the key interest rate issued by the Bank of Canada. Basically, if the key interest rate increases, so do variable-rate mortgages. 

The key interest rate is adjusted according to the economy and inflation rate. The stronger the Bank of Canada expects inflation and the economy to be in the coming months, the higher the key interest rate will be to curb inflation. 

Beware! Although closely linked to the key interest rate, the prime rate can sometimes fluctuate between periods when the key interest rate changes. For example, the prime rate could increase in anticipation of future increases in the key interest rate. 

Fixed mortgages rates 

Fixed mortgage rates are influenced by long-term Government of Canada bond rates. For example, fixed mortgage rates for a five-year term vary in relation to a five-year Canadian bond rate. Bond rates fluctuate with the stock market, which are influenced by long-term economic and inflationary forecasts. 

What do I do if interest rates decrease? 

If particularly favourable rates are in effect or if an exceptional rate decrease is expected, you could:   

• Switch your variable-rate mortgage to a fixed-rate mortgage. 
  
• Renew your mortgage early and with no penalties, as long as it matures in the following 6 months. 
  

Be careful, if your loan doesn’t mature for a long time, get out your calculator: 

• The total amount you’d spend on the penalty could exceed the savings you’d get from a lower rate. 
  
• Your early renewal might not be worth it.  
  

What do I do if interest rates increase? 

As soon as a rate increase is announced, you immediately ask yourself: what impact will it have on my mortgage payments? We get it. An increase can have a (possibly immediate) impact on your payments if you have a variable-rate mortgage or renewal coming up.   

Before making any drastic decisions, here are a few solutions in case interest rates go up: 

• If your monthly payments are already a big part of your expenses and your loan is maxed out, evaluate other areas of your budget that could be optimized. 
  
• If you can afford to do so, build a savings cushion that you can use if there’s an increase.   
  
• Consider converting your variable-rate mortgage to a fixed-rate mortgage. That way, if one or more increases are expected, you can stabilize your rate and monthly payments for easier budgeting. 
  
• If you want to keep a variable rate, consider accelerated repayments in one lump sum or periodic payments when rates are low. This would allow you to adjust your budget now to prepare for possible rate increases. 
  

First-time home buyers: mortgage planning tools 

Now let's move from theory to practice and assess your tolerance for fluctuating monthly payments. Here are some mortgage planning tools to help you predict the costs for a first-time home buyer and develop a realistic annual budget: 

• Article: "What are the real costs of buying a property?” 
  
• Article: "The annual costs associated with a house" 
  
• Payment calculator: estimate your mortgage payments 
  
• Loan calculator: calculate your borrowing capacity 
  

A tip for peace of mind: While looking for a home, you can lock down a good mortgage rate against possible increases with a mortgage pre-approval. It will also help you simplify your buying process by certifying your borrowing capacity, especially when it comes to making an offer to purchase.