In Canada, there are two main types of mortgage rates - a fixed rate and a variable rate - and both have their own pros and cons. Understanding the difference between these two types of mortgage rates can be daunting - especially when you aren’t very familiar with the terms - however it is extremely important for homebuyers and homeowners to understand their mortgage rate options BEFORE making a financial commitment.
How do you know which mortgage rate is best for you, your budget and your goals?
The House Team in Belleville, Ontario, is focused on making the mortgage process as simple and straightforward as possible. This season, we’re seeing aggressive pricing for variable rate mortgages, while fixed mortgage rates continue to be at historically low levels. We frequently conduct research on which type of mortgage is best for today’s uncertain environment in order to properly advise and direct each of our clients.
Which is best for today’s uncertain environment? Let’s find out!
What is a Fixed Rate Mortgage?
If you choose a fixed-rate mortgage, you will know with absolute certainty what your interest rate and mortgage payment will be each month for the entire term of your mortgage. This often offers stability and peace of mind - especially for first time home buyers, those on a tight budget or those who haven’t owned a home in quite some time.
Since a fixed rate mortgage is not affected by fluctuating interest rates, you can essentially "set it and forget it".
What is a Variable Rate Mortgage?
If you choose a variable rate mortgage, your interest rate will fluctuate with your lender’s Prime Rate, which in turn tracks the Bank of Canada’s overnight rate - expressed as “prime minus x percent.”
If the Bank of Canada increases or decreases its rate, you will likely see this change reflected in your monthly mortgage payment. Since it can be difficult to predict what kind of increases and decreases are ahead of us, a variable-rate mortgage is best suited to people who have a flexible budget and can tolerate a higher risk.
What Is Prime Rate?
Haven’t heard this term before? Don’t worry!
Prime rate refers to the ‘reference rate’ that banks use as the lowest commercial interest rate charged at that time. Yesterday the prime rate was 2.45%.
It’s important to note here that the prime rate is actually used to calculate the variable rate mortgage, as it acts as the base percentage amount.
The prime rate is reviewed 4 times per year and has not changed in 2 years...however the possibility of it fluctuating still exists.
Which is Better in 2021 - Fixed Rate or Variable Rate?
It’s important to consider the many “what if” scenarios that could happen over the term of your mortgage. Right now, and in today’s intense housing market, variable rate offers are very compelling - causing the housing demand to be at some of the highest levels ever seen.
Benefits of Fixed Rate Mortgages:
- “Set it and forget it”
- Releases budget stress
- Provides financial stability
Benefits of Variable Rate Mortgages:
- Historically speaking, variable rates are usually less expensive over the term (approximately 5 years).
- Variable rate is usually lower than the fixed rate.
But it’s not just about the rate…
If you decide to break off your mortgage prior to the end of your term, you will be charged. This charge is called a prepayment penalty. If you are in a fixed rate mortgage, this penalty is the greater of three months interest OR interest rate differential (IRD), the greater of the two. If you are in a variable rate mortgage, the penalty is only three months interest.
If your circumstances change (whether you are accessing equity or refinancing at a lower interest rate) and you need to get out of your mortgage, you will appreciate the much lower penalty to get out of a variable rate vs. a fixed rate mortgage.
Note: Approximately 2/3 people with fixed mortgages do actually end up breaking their mortgage prior to the end of the term.
Most variable rate mortgages will allow you to exercise an option to “lock in” a fixed rate with zero penalties when the time is right to switch over to a fixed-rate mortgage. At this point, you can also set up your mortgage payments at what they would be if you took the higher fixed rate, which helps you pay down your mortgage faster and creates a financial buffer for you if interest rates rise later.
With inflation concerns on the horizon, the Bank of Canada may raise the overnight rate sooner than expected, which will affect those in variable mortgages. While most economists agree that no one can predict what will happen with inflation as the economy continues to reopen, it is a continual unknown.
Refinancing Your Mortgage With a Fixed or Variable Mortgage Rate
As mentioned above, it is possible to refinance with a fixed or variable rate mortgage, however both have their penalties.
Refinancing With Fixed Rate Mortgage: 3 Months Interest OR Interest Rate Differential (IRD), the greater of the two
Refinancing With Variable Rate Mortgage: 3 months interest
Bottom line is to always get advice; the best choice depends on your specific situation.
You Can Trust The House Team in Belleville, Ontario With Your Mortgage Needs
If you are looking to purchase, renew, or refinance your mortgage in order to get today’s low rates, or for debt consolidation, get in touch with The House Team! We will discuss your specific situation and help determine the best mortgage option for you moving forward.