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Should You Get a Fixed or Variable Mortgage in Canada?

The economy has had a significant effect on mortgage rates, and there are a few factors that play a role. In Canada, there are fixed and variable mortgage rates.

Choosing between a fixed or variable mortgage rate can be one of the most significant decisions you make when buying a home. Choosing the wrong interest rate could cost you thousands of dollars in the long run!

Before making any decisions, explore the differences and what makes each rate unique.

Fixed-Rate Mortgages

When your mortgage rate stays the same throughout the payment term, it gets known as a fixed-rate mortgage. Suppose you have a 20-year fixed-rate mortgage; your rate will get set for the whole duration of the term. Many refer to it as “locking in” your rate.

Terms can be long or short, with the most common being for five years. For example, if your mortgage has a fixed rate of 3%, you will pay annual interest at a rate of 3% for the full five years, even if Canada’s interest rates rise or fall during that period. You will get to renegotiate the mortgage for another term and get the opportunity to select either a fixed or variable mortgage. This cycle will continue until your mortgage gets paid in full.

Fixed-rate mortgages are great for new homeowners who need to know their mortgage payments for years to come due to their income staying the same for years before increases. It’s also very convenient for people because you can budget more effectively.

Variable-Rate Mortgage

When your rate changes during the mortgage term, it gets called a variable-rate mortgage. If, for example, you have a ten-year variable-rate mortgage loan, your rate can change at any point during the mortgage term.

These changes usually happen when the Bank of Canada adjusts its interest rates. The variable rate gets based on the lender’s prime rate, which only gets offered to customers with high credit scores and good payment history.

A variable rate mortgage gives you the advantage of converting fallen interest rates into a fixed-rate mortgage at any given point.

Variable-rate loans generally have a lower interest rate compared to fixed-rate mortgages. This is due to a variable rate being riskier. Even though there’s a higher risk, you have the opportunity to pay your loan off quicker.

Fixed Payments with a Variable Rate

If the interest rate increases, the payments that go towards the interest will be more, and less will go to the principal amount.

If the interest rate decreases, the payments that go towards the principal amount will be more. You will then have the chance to pay your mortgage off faster.

Your lender can increase your payments if the market interest rates rise to a trigger point or a specific percentage. The increase in payment ensures you settle your mortgage by the end of the amortization period. You can find the trigger point in your contract.

The Pros And Cons Of Fixed and Variable Mortgage Rates

There are some pros and cons to take into account for both a variable rate and fixed-rate mortgage loan.

Fixed Mortgage Rates

Pros

  • You can easily create a good budget and know that the payments will remain consistent.
  • You never have to worry about interest rates increasing during the mortgage term.

Cons

  • You might miss on savings if there is a decrease in the interest rates for the mortgage term.
  • There are penalty fees if you break the contract in the middle of the mortgage term.

Variable Mortgage Rates

Pros

  • Variable-rate mortgages are known to have outperformed fixed rates.
  • You will have more flexibility and can lock in an interest rate at any given time.

Cons

  • Because rates fluctuate, you can pay more when interest rates rise.
  • The fluctuation of interest rates makes it difficult to budget your money.

How to Decide Between a Fixed and Variable Mortgage Loan

Mortgage interest rates have been historically very low. Therefore, you can benefit from low-interest rates with a fixed mortgage rate over the long term. However, if you are looking to refinance or sell your home, a variable rate could give you lower rates and make it more affordable over the short term.

If this situation, it’s detrimental to determine how long you plan on having a mortgage. Adjusting rates could lead to you locking in a higher rate than what you had initially anticipated with a fixed rate. With a long-term debt like a mortgage, the slight difference between two interest rates can mean thousands of dollars over 30 years.

How to Protect Yourself with Rising Interest Rates

Your payments will increase if interest rates rise. Ensure you can adjust your budget if your mortgage payments increase. Find out from your lender if they can offer the following:

  • A convertibility feature – Where you can change or convert your mortgage at any time during your term to a fixed interest rate.
  • An interest rate cap – This is the maximum interest rate that can get charged by your lender on a mortgage. Although interest rates increase, you don’t pay more than the maximum cap in interest.

If you select a convertibility feature and get your mortgage rate changed to a fixed rate, the following will occur:

  • Generally, you have to pay a fee
  • Particular conditions can apply
  • Your new fixed interest rate can be higher than the variable interest rate that you’ve been paying

Conclusion

If a lender offers low rates for a fixed-rate mortgage, it will make sense not to choose a variable rate mortgage. However, if you plan to sell your home shortly, you could get penalized for cancelling your contract before the end of the term.

On the other hand, choosing a variable-rate mortgage affords you the possibility to lock in an interest rate at any given time throughout your contract.

Whichever route you choose to go, ensure you have done your research and consider your plans and whether you can afford fluctuating interest rates.

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