A fixed rate mortgage is a mortgage with a guaranteed interest rate. This means for the length of your term, you will get the same fixed interest rate you signed up for, even if rates rise. Many people opt for a fixed rate mortgage because they offer security and predictability since you know exactly how much your mortgage payments will be. This can help assist with future planning and budgeting.
For a 5 year fixed mortgage, you will get the same fixed interest rate you signed up for for 5 years, even if rates rise. 5 year fixed mortgages generally have the best mortgage rate compared to other fixed mortgage terms. They are offered by almost all lenders and if you are planning to refinance or switch lenders, then a 5 year fixed mortgage might be the best place to start.
With a 5 year fixed mortgage, you are provided with risk protection as your mortgage payment and rate are locked in and will not fluctuate with changes in bond yields. This will allow you to budget more accurately and will provide you with stability for the duration of your term. With a 5 year fixed rate mortgage, you also get competitive rates since many people go with the 5 year duration, making lenders more aggressive when pricing.
A con with getting a 5 year fixed rate mortgage is that if you choose to decide to break your mortgage, your penalty will be the greater of the interest rate differential (IRD) or equivalent to 3 months worth of interest. An IRD penalty can be a significant amount, meaning it could be very costly to break a fixed rate mortgage. Another con with 5 year fixed mortgages is that there are higher rates, as lenders will charge a premium in order to guarantee your fixed rate. Historically, variable rate mortgages will require less interest paid compared to fixed rate mortgages.
The term is the set amount of time you are committed to the fixed interest rate you sign up for. The 5 year fixed mortgage is the most common in Canada. However 5 year terms are not the only option. You can choose a term length ranging from 1 to 10 years. Some people choose a 3 year fixed rate mortgage as it is a shorter commitment, and some choose a 10 year fixed rate mortgage as it offers more stability but will come with a higher interest rate.
With a variable rate mortgage, your mortgage rate can change over time depending on the Bank of Canada’s Prime Rate. Your mortgage payments will stay the same with a variable rate mortgage but the amount of interest will fluctuate throughout your term, and when rates increase, less of your payment will go towards your principal and will go towards interest.
With a fixed rate mortgage, your interest rate will stay the same for the entire term. However, fixed rate mortgages often have a higher rate because there is no risk of market interest rate changes. Whether you want to go with a fixed rate or variable rate mortgage will depend on how much risk you are willing to take. With a fixed rate, you will have the predictability but could potentially pay off your home at a slower rate if mortgage rates drop, or you could have a lower interest rate with a variable rate mortgage but would be at risk of higher interest rates in the future.
In 1981, the 5 year fixed mortgage rate was at an all time high at 21.75% in Canada caused by low economic growth and high inflation. Now in 2022, fixed rate mortgages are lower sitting at 4.74% caused from effects of COVID-19, which cause the Bank of Canada to drive down the Prime Rate down to 0.25% and 2.45%.