If you're reading this, you're probably planning to buy a home. You'll have to make a lot of decisions to make over the coming months. One of the first is whether to opt for a fixed or variable interest rate.
Choosing between a fixed and a variable rate is like choosing between smooth and crunchy peanut butter. Which one should you pick? Spoiler alert: To find the right answer, you've got to listen to your gut.
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When you sign a mortgage deed, your bank locks in your interest rate. This rate determines your payments over a fixed period, generally 5 years. During this period, you'll be required to repay your loan or home equity line of credit at the frequency you chose when you signed the deed: weekly, every two weeks or monthly.
In simple terms, your rate is the percentage you pay and your term is the period you pay it over.
By definition, a fixed rate is just that: it doesn't change throughout the term of your loan. So you'll be paying the exact same amount each time you make a payment. Reassuring, isn't it? Since it's as certain as the sun rising in the morning (which you'll be able to see from the balcony of that high-rise condo you've been eyeing), a fixed rate is recommended for first-time home buyers, people who are on a tight budget and people who value financial stability. If you like to compare yourself to others, keep in mind that the vast majority of mortgage loans are fixed rate.
Fixed rates are generally a little higher than variable rates. But sometimes things go topsy-turvy, and variable rates swing higher than fixed rates.
Variable rates are the crazy cousin of the family. You've guessed it—they vary. Variable rates change depending on the country's economic situation. The Bank of Canada's key rate can change each month, and variable mortgage rates change along with it. That means your mortgage payments could go up or down.
So over a five-year term, your variable rate—as the name implies—is likely to vary. These increases and decreases are generally gradual, and don't change drastically from payment to payment. For example, if you have a $200,000 mortgage loan, a 0.25% change in the key rate would increase your payments by $27 per month. All things considered, we recommend a variable rate for people who can manage fluctuations in their budget. If you get heartburn every time you have to pay more for your morning coffee, a variable rate probably isn't for you.
If you follow the crowd and opt for a fixed rate, next you'll have to choose if you want an open or closed loan. What's that? First off, you should know that a fixed-rate loan can be open or closed, while a variable-rate loan is always closed.
If you choose an open mortgage loan, you can repay the principal at any time without penalty. By penalty, we mean a charge—you won't have to spend a few minutes in the box. What's the downside? Your rate will be higher. People who choose an open loan often have plans to resell in the near future. If you're looking to buy a condo that's seen better days so you can fix it up and flip it, an open loan may be right for you.
Closed loans have much longer terms—up to 10 years. They offer lower rates than an open mortgage, but you'll have to pay a penalty if you pay your loan down early.
During your first meeting, your mortgage advisor will talk you through your budget, your medium- and long-term needs and your risk tolerance. The key question you need to ask yourself is, "If my mortgage payments increased, would I still be able to pay them?"
You'll have a chance to go home and talk it over with your family so you can make an informed decision about which mortgage rate is right for you. Remember that your rate will be up for review when you renew your loan. At renewal, you'll also be able to adjust the amount and frequency of your payments for the next few years.
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