What is the Difference Between Fixed and Variable Rate Mortgages?

| April 30, 2014

Fixed and Variable Rate MortgagesIf you are trying to determine the difference between fixed and variable rate mortgages, Read this article to establish what will suit your needs. 

Besides different terms and amortizations, mortgages will also be either fixed-rate or variable rate. Both offer advantages and disadvantages at times, and you should be aware of what they are.

Fixed-Rate Mortgage

As the name suggests, a fixed-rate mortgage stays at the same interest rate throughout the term of the mortgage. When the term expires, the mortgage is renewed at whatever the interest rate is at that time. During the term, you pay the same amount in payments each and every month. The attractiveness of a fixed-rate mortgage is obvious as it is reliable and you can easily budget for your monthly payments. In fact, 66% of homeowners choose a fixed-rate mortgage. Part of this is because they are simple and easy to understand, but what you may not know is that a fixed-rate mortgage may not be the best choice every time.

When interest rates are low, snapping up a low rate and locking it in may make perfect sense providing rates are forecast to rise; however when interest rates are high, locking into a high rate may not make sense at all. If interest rates take a nose dive, the only way a fixed-rate mortgage can be adjusted is by refinancing. There are often fees to do this, and refinancing requires the time and energy required to dig up all the paperwork that you need to apply and qualify again. Plus fixed-rate mortgage rates are often substantially higher in the first place.

Variable-rate mortgages often offer lower rates and payments early on in the mortgage term. As payments are lower, buyers can often qualify for larger mortgages and buy more expensive homes. Buyers also have the option of taking the money that they would have spent on a higher fixed-rate mortgage payment. Using it for investments instead, like investing in a rental or vacation property. Variable-rate mortgages also offer an advantage to buyers who are not planning on staying in the home for a long period of time, or if their work requires frequent moves. It simply doesn’t make sense to pay the extra money in monthly payments if you do not have to.

Variable Rate Mortgage

Variable rate mortgages are more complex. They are based on the “prime” lending rate that is set by the Bank of Canada. Lenders usually raise or lower their rates according to what the Bank of Canada does. How does the Bank of Canada determine its’ rates? They examine what is happening economically in our country. When inflation is high, the bank increases the prime lending rate. This is to slow down the economy by making borrowing more expensive. When inflation is low, the prime rate goes down to encourage people to borrow to get the economy going again.

A variable-rate mortgage offered by a lender as the Bank of Canada’s prime lending rate, plus or minus a percentage. This percentage stays the same as the prime rate floats up and down. For example, if the prime interest rate is 4%, your lender may offer you a variable mortgage of prime plus 2%, or 6%. If the prime rate goes down to 3%, your payments would decrease as your interest rate would now be 3% plus the 2%, or 5%. Conversely, if the prime rate goes up to 5%, your payments would increase as your interest rate would be 5% plus 2%, or 7%. The relationship to the prime rates stays constant over your term.

During times when interest rates keep dropping, a variable-rate mortgage can save you a considerable amount of money. The obvious disadvantage is that rates and payments may rise over the span of the term if interest rates increase.

Clearly, choosing between fixed and variable rate mortgages requires expertise and industry knowledge. This is why the services of a Mortgage.ca mortgage specialist are so worthwhile. They have the training and product knowledge that could save you money now and down the road. Talk to a qualified broker today to find out which mortgage is right for you.

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