When people hear that I’m a mortgage broker, the first question that they usually ask is, “what’s your best rate?”
Now, I love getting questions, but this one is really tough to answer, especially at the beginning of a mortgage conversation. The ‘best rate’ depends on a number of things.
The rates advertised by banks and lenders and what your contract rate will actually be are usually very different. Your contract rate depends on how much you have for a down payment, the property you choose, the mortgage product, and other factors.
But, I do believe that knowing the difference between a fixed or variable interest rate mortgage is still a good thing.
Interest Rate Basics
The primary difference between a fixed or variable rate mortgage is how much you will pay monthly in interest.
With a fixed-rate mortgage, the amount you pay each month will stay the same for the entire length of your mortgage term. If you like consistent payments each month that don’t change, a fixed rate is a good option.
With a variable rate mortgage, the amount you pay can potentially change each month, as the interest will change based on the prime lending rate set by the Bank of Canada, described as Prime +/- a certain amount. For example, “Prime - 0.75%.”
If you are the type that can’t sleep at night knowing that your rate may change by .25%, a variable rate mortgage may not be the best option for you.
Can You Afford to Take a Variable Rate Mortgage?
There is some risk associated with a variable rate mortgage, and you need to assess your ability to pay the mortgage in the event that rates do rise. I do this assessment with you during the pre-approval process. This is called the Stress Test where I qualify you at a higher rate than what you’ll likely be paying to determine if your finances could handle an increase in rates.
Expert Tip: To make sure you can continue to afford your mortgage, pay more than the minimum monthly requirement, even just slightly. This will give you a bit of a cushion if the rate goes up during your mortgage period.
Setting your payments higher (if your lender allows you to do so) will also allow you to further take advantage of the lower variable rate by allocating more of your payment to pay down the principal.
Is the Fixed Rate Always Lower Than the Variable Rate?
Prime Rate has been fairly low for the last several years so buyers who chose a variable rate mortgage were often paying less than those who chose a fixed rate.
However, the COVID-19 pandemic and the current economic situation in Canada have pushed fixed interest rates low, with some fixed rates potentially being lower than variable rates. This has been very beneficial for homeowners whose financial or employment situation changed during the pandemic.
Of course, there are speculations that rates will be increasing in the next year, with expectations anywhere between 1.75 and 3% by the end of 2023. Now, these are still considered normal rates, so not to worry about substantial increases.
What Should You Look for When Choosing Between a Fixed and Variable Rate Mortgage?
Just keep in mind that no one can predict where rates are going to be with any certainty. 2020 was a year none of us were prepared for, interest rates and otherwise. Also, none of the economists who make the predictions will be making your mortgage payments so you have to understand what works for your budget.
Payment Frequency – Make sure you are aware of the options available before deciding. Some lenders may not allow certain variations of payment frequency.
Prepayment Options – Prepayment options are a great way to pay down the principal of your mortgage faster, but some lenders will limit how much you’re allowed to put down each year.
Penalties – Do you think you’re going to break your mortgage before 3 or 5 years? A variable rate mortgage typically has a penalty of three months interest. Fixed-rate mortgages may have higher payment penalties determined by using a complicated formula called Interest Rate Differential.
Conversion to Fixed Rate – If you stay with the same lender, you should be able to switch from a variable-rate to a fixed-rate mortgage with no penalty, however, the rate you pay may change.
This is the final thing I’ll say about interest rates: getting a good mortgage isn’t just about getting the lowest interest rate!
Rate is only a part of the equation and you definitely don’t want to be paying more interest than you have to. So, let’s chat. I promise I’ll still answer your question if you ask, “what’s your best rate?”