Fixed vs Variable Rate Mortgages
Fixed Rate Mortgage vs. Variable Rate Mortgage: Which One is Right for You?
When choosing a mortgage, one of the biggest decisions you’ll face is whether to go with a Fixed Rate Mortgage or a Variable Rate Mortgage. Each option has its benefits and risks, and understanding the differences can help you make a confident decision. Let’s break them down.
What is a Fixed Rate Mortgage?
A Fixed Rate Mortgage locks in your interest rate for a set term (e.g., 1 year, 3 years, 5 years, or even 10 years). This means your mortgage rate stays the same throughout the term, giving you stability and predictable monthly payments.
What is a Variable Rate Mortgage?
A Variable Rate Mortgage has an interest rate that fluctuates based on the lender’s Prime Rate. Your lender may offer you a rate such as Prime - 0.50%, meaning if the Prime Rate is 5%, your actual mortgage rate would be 4.50%.
Since the Prime Rate can go up or down, so will your mortgage rate—and possibly your mortgage payments.
How Does the Prime Rate Affect a Variable Rate Mortgage?
When the Bank of Canada changes its Overnight Lending Rate, lenders typically adjust their Prime Rate accordingly. If the Prime Rate rises, your variable mortgage rate and payments may also increase. Conversely, if the Prime Rate decreases, your mortgage payments could go down.
For example:
If the Prime Rate is 5% and your lender offers Prime - 0.25%, your rate is 4.75%.
If the Prime Rate rises to 5.5%, your rate increases to 5.25%, resulting in higher mortgage payments.
If the Prime Rate decreases, you’ll enjoy lower payments.
How Often Does the Prime Rate Change?
The Bank of Canada typically holds eight announcement dates per year where they may choose to increase, decrease, or maintain the Overnight Lending Rate. These announcements are important to monitor if you have a Variable Rate Mortgage.
On Jan 29th, 2025 the Bank of Canada has cut its overnight key interest rate by 25 bps to 3.00%.
What influences Fixed and Variable Rate?
Fixed-rate mortgage rates in Canada are priced off of Government of Canada 5-year bond yields that are, in turn, influenced by the U.S. Treasuries.
Variable-rate mortgages are affected by the Bank of Canada's monetary policy, namely interest rate hikes and cuts that, in turn, impacts commercial banks' Prime lending rate.
Understanding the Prime Rate in Canada:
The Prime Rate is the interest rate that major banks in Canada use to set interest rates for variable loans/mortgages and lines of credit. It’s influenced by the Bank of Canada’s Overnight Rate, which is the rate at which banks borrow and lend to each other overnight.
Consider the prime rate as the foundation upon which these other interest rates are built. As the prime rate in Canada fluctuates, the interest rate you pay on your adjustable/variable rate mortgage also adjusts accordingly.
If you are like me, and you like to look at numbers, here is a table summarizing the Prime Rate changes in Canada from 2010 to today. This table captures the key changes in the prime rate along with the dates and the magnitude of changes from 2010 to today.
| Effective Date | Prime Rate | Change |
|---|---|---|
| Upcoming: March 12th | ||
| Jan 29th, 2025 | 5.20% | -0.25% |
| Dec 11th, 2024 | 5.45% | -0.50% |
| October 23, 2024 | 5.95% | -0.50% |
| Sept 4, 2024 | 6.45% | -0.25% |
| July 24, 2024 | 6.70% | -0.25% |
| June 5, 2024 | 6.95% | -0.25% |
| July 12, 2023 | 7.20% | +0.25% |
| June 8, 2023 | 6.95% | +0.25% |
| January 25, 2023 | 6.70% | +0.25% |
December 8, 2022 | 6.45% | +0.50% |
| October 27, 2022 | 5.95% | +0.50% |
| September 8, 2022 | 5.45% | +0.75% |
| July 14, 2022 | 4.70% | +1.00% |
June 2, 2022 | 3.70% | +0.50% |
April 14, 2022 | 3.20% | +0.50% |
| March 3, 2022 | 2.70% | +0.50% |
| March 30, 2020 | 2.45% | -0.50% |
| March 17, 2020 | 2.95% | -0.50% |
| March 5, 2020 | 3.45% | -0.50% |
October 25, 2018 | 3.95% | +0.25% |
| July 12, 2018 | 3.70% | +0.25% |
| January 18, 2018 | 3.45% | +0.25% |
| September 7, 2017 | 3.20% | +0.25% |
| July 13, 2017 | 2.95% | +0.25% |
| July 16, 2015 | 2.70% | -0.15% |
| January 28, 2015 | 2.85% | -0.15% |
| September 9, 2010 | 3.00% | +0.25% |
| July 21, 2010 | 2.75% | +0.25% |
| June 2, 2010 | 2.50% | +0.25% |
Pros and Cons of Each Mortgage Type
Benefits of a Fixed Rate Mortgage:
- Predictability: Your interest rate and payments remain the same until renewal.
- Stability: Ideal for those who prefer budgeting with certainty.
- Peace of Mind: No need to worry about rate fluctuations affecting your payments.
Benefits of a Variable Rate Mortgage:
- Potential Savings: If the Prime Rate continues to go down, you can save on interest costs.
- Flexibility: You may be able to lock into a fixed rate later if needed.
Switching from Variable to Fixed Rate
If you start with a Variable Rate Mortgage but become concerned about rising rates, many lenders allow you to convert to a Fixed Rate Mortgage during your term.
However, it’s important to understand:
- You’ll lock in at current fixed rates at the time of conversion, not the rate you originally qualified for.
- Some lenders may offer their best fixed rate, while others may provide a higher posted rate—so ask in advance.
Strategy for Managing a Variable Rate Mortgage
If you choose a Variable Rate Mortgage but want to minimize risk, consider setting your monthly payment higher than required. For example, set your payment as if you were on the current five-year fixed rate. This allows you to:
- Pay off more principal while rates are low.
- Create a buffer in case rates rise in the future.
- Reduce overall interest costs and stay ahead of your amortization schedule.
Which Mortgage Type is Right for You?
A Fixed Rate Mortgage is great for those who prioritize stability and want predictable payments. A Variable Rate Mortgage can be beneficial if you’re comfortable with some risk and want to take advantage of potential interest rate savings.
Ultimately, the right mortgage depends on your financial goals, risk tolerance, and market conditions. If you’re unsure, consulting with a mortgage broker can help you make the best choice for your situation.
As always, I am here to answer any mortgage related questions that you may have and help you crunch any numbers that you don’t quite understand - book a call here.