Last updated: September 14, 2023
Deciding between going with a variable or fixed mortgage rate is probably one of the biggest decisions you will make when selecting a mortgage. Each choice will have its own benefits and downsides and will affect the amount of interest a homeowner will have to pay for years to come. When it comes to deciding between a variable and fixed mortgage, there are several factors you should consider.
Rates can continue to increase indefinitely and there is no guarantee about peak variable rates.
Some questions you can ask yourself when you are deciding between a fixed rate or variable rate:
If the answer to the above questions are yes, then a fixed rate might be the best option for you. With a fixed rate, you won’t need to worry about your payments increasing as you will have a fixed rate for a specific amount of time and won’t need to watch rates. With less than 20% down, you are likely to get a lower interest rate that you can lock in, since you are required to get mortgage default insurance.
If yes, then a variable rate mortgage might be the best option. With a variable rate, you have the option to lock in a fixed rate at any time for the remainder of your mortgage term or longer. You can also increase your payments if permitted by your lender, which helps you pay down your mortgage faster and will create a financial buffer for you in case rates do rise.
Historically, a variable rate mortgage has proven to save borrowers money. Variable mortgages also offer a predictable penalty fee if you choose to break your mortgage before the end of the term, since it will always be equal to 3 months interest.
With a variable rate mortgage, you might face financial uncertainty as you never know when rates will rise and could be difficult when it comes to budgeting. If the ‘prime rate’ were to increase, this will also lead to an increase in your mortgage payment. Depending on your mortgage agreement, this could either mean higher monthly payments or changes in your amortization while your monthly payment stays the same.
The pros of a fixed rate mortgage is the predictability. Your monthly mortgage payments will be consistent for the duration of your term regardless of which way rates move, offering stability when it comes to budgeting.
The cons of a fixed rate mortgage is uncertainty regarding penalty fees if you choose to break your mortgage before the end of the term. Fixed rates will calculate the penalty based on the greater of a 3 month interest penalty or an interest rate differential (IRD), which is just a fancy way of saying that you pay the lender for all the interest they’re missing out on for the rest of your term. This is most punitive in a falling rate environment, meaning rates are lower than when you first got your mortgage. If you have a variable rate mortgage or rates have gone up since you first got your fixed rate mortgage, it’s likely that you’d pay a 3-month interest penalty under either scenario.
Referring to Perch’s mortgage applications, it was an even split with people opting for fixed or variable 50/50.
Perch’s mortgage advisors always recommend consulting a mortgage professional to help you make this decision, but it comes down to two things: The numbers and the situation.
The numbers can be calculated using our Pathfinder tool and it breaks down the effective cost of borrowing under a fixed or variable rate that takes into account expected rate increases. We quantify the expected benefit of one over the other through our “total savings”. Purely from a numbers standpoint, the option with the most savings is the best option.
The situation is the part that mortgage advisors can assess after meeting with you. Some people would stress immensely with the thought of rates potentially changing and are willing to pay more for peace of mind. Also, variable rates are typically only available in 3 or 5 year terms and if someone needed a shorter term it may not be a good fit.
The attractiveness of a variable rate from a financial standpoint is mainly in relation to a fixed rate. Historically, variable rates were well below fixed rates which gave borrowers the benefit of low monthly payments. However, the rate difference between fixed and variable rates today has flipped as lenders are pricing in a higher chance that rates will be lower in the next 5 years.
With no immediate benefit, the main rationale for going variable in late 2023 would be to bet on a recession. If the Canadian economy contracts, the Bank of Canada would be expected to cut their overnight rates, which should then result in banks lowering their prime rate.
If you get a variable rate, any movements in the prime rate will only affect your amortization (how long until you pay off your mortgage) and your payments will remain unchanged (unless you surpass the trigger rate, but that’s extremely uncommon). This is in contrast to an adjustable rate mortgage, where the payments change and your amortization remains the same. A variable rate would thus be less volatile from a cash flow standpoint.
You also need to pick the right mortgage lender. Some lenders offer re-advanceable home equity lines of credit which you can use to reduce your mortgage payment if rates rise beyond your comfort level.
Consider rental income. If any part of your home could be rented out, that additional income could be used to offset a higher mortgage payment.
Finally, as the “break glass in case of emergency”, most lenders allow you to lock in a fixed rate with no penalty at any time in your mortgage term. So if the outlook for variable rates drastically changes, you would be able to lock in a fixed rate. Note that lenders typically take a few days to adjust rates to changes in the market, so you’d have to move quickly on this. Perch helps you track the ability to switch on a weekly basis automatically, so we can help you with this!