The rate debate: whether you should go with a fixed or variable mortgage

One of your first decisions when you buy a home is to decide on a fixed- or variable-rate mortgage. Fixed-rate mortgages allow borrowers to lock in at a particular interest rate for the term of their mortgage, no matter what happens to interest rates. Variable-rate mortgages, on the other hand, fluctuate with the Bank of Canada’s quarterly decisions on interest rates.

It’s possible for Canadians to benefit from a hybrid option, which allows borrowers to take advantage of both variable and fixed rates. They’re partially protected in case rates go up and have the benefits of a variable rate if the interest falls. But for now, we’ll focus on fixed- and variable-rate mortgages, as they are the most common in Canada.

According to a 2020 report from Canadian Mortgage Trends, 74% of mortgage holders had a fixed-rate mortgage in 2019. That was up from 68% the previous year. Meanwhile, 21% of mortgage holders went with variable-rate mortgages, a drop from 27% in 2018.

If you’re buying a new home, renewing or refinancing an existing mortgage, which type of mortgage should you go with? Let’s look at the pros and cons of each:

The pros and cons of a fixed-rate mortgage

Like the name implies, a fixed-rate mortgage is set for the entire mortgage term. Your interest rate and payments remain the same. These mortgage rates are set by the Government of Canada’s bond yields at the time of purchase and don’t change even if the yields change. 

Pros:

• You know exactly how much interest you’re paying on every single mortgage payment. That can help you when you’re planning your household budget. 
• You’re immune to the effects of fluctuating interest rates.

Cons:

• Fixed interest rates tend to be higher than variable rates. The difference is often less than 1%, but that can add up over the years. 
• Penalties can get expensive if you decide to break your current mortgage to take advantage of lower rates. 

The pros and cons of a variable-rate mortgage

Variable-rate mortgages are subject to rate fluctuations when the prime rate (set by the Bank of Canada) changes. You’ll often hear that variable mortgage rates are “set at prime plus or minus” a certain percentage, which could be a discount or a premium set on the prime rate. This can affect your payments and the amount of interest you pay on your mortgage because if the prime rate increases, so does your mortgage rate. More of your payment goes toward paying off the interest instead of the principal. And the opposite happens if the prime rate is cut. 

Pros:

• Variable-rate mortgages often have lower interest rates than fixed-rate mortgages, which can mean more money being put toward the principal. 
• Historically, variable rates have been less expensive over time. 
• It’s easier to lock into a fixed-rate mortgage if rates start rising, whereas it’s harder and more expensive to break a fixed-rate mortgage due to penalties. 

Cons:

• Your payments could go up depending on the prime rate. If the prime rate goes up, more of your payment will go toward the interest versus the principal.
• You will have to be aware of what the prime rate is doing in case you’re interested in locking into a fixed-rate mortgage. There’s no “setting and forgetting” with variable-rate mortgages. 

Which is better: a fixed-rate or variable-rate mortgage? 

If you’re risk-averse and like knowing how much you pay every month, then a fixed-rate option will work for you. If you’re not as risk-averse, have the financial means to afford a slightly higher payment, are willing to keep an eye on the prime interest rate or email your mortgage broker regularly, then a variable rate might be the better option. 

But remember: interest rates aren’t everything. When you’re shopping around for a mortgage, it’s always important to compare the interest rates between fixed and variable rates. You should also look at:

• Mortgage principal 
• Amortization period
• Payment frequency
• Whether or not your lender requires you to have title insurance
• Your property taxes. Will you be able to afford both the mortgage payment and the taxes? 
• Whether your mortgage is open or closed (so you can pay it off faster), is assumable, (meaning a buyer could take over the mortgage when you sell your home without any changes to the term), or is portable if you move to a new home.

Take the time to understand your financial position, shop around and get a mortgage that’s right for your needs.