Fixed-rate vs. variable-rate loans, what is the difference and which one should you choose?
When taking out a loan, particularly when it comes to mortgages, you will be tasked with choosing between a fixed rate and a variable rate. But, do you know the difference and how each rate type will affect your debt? Keep reading to learn about fixed and variable rates.
Key Points
- Variable interest rates are commonly available for mortgages and lines of credit.
- Fixed interest rates are commonly available for personal loans, mortgages, credit cards and car loans.
- Variable rates can increase or decrease based on the prime rate, which can make them more or less expensive than a fixed loan depending on market and economic conditions.
- A fixed rate is preferred by many Canadians due to its predictable and stable payments, making it easy to calculate cost and budget for.
Fixed-Rate vs. Variable-Rate
A fixed-rate and variable-rate can dramatically change the cost of your loan and payments.
What Is A Fixed-Rate?
A fixed rate on a loan is where the interest rate will remain the exact same throughout the duration of your term, no matter how much the market fluctuates. This means your monthly payments throughout your loan term will remain the same.
What Is A Variable-Rate?
A variable rate on a loan means the interest rate can fluctuate throughout the lifetime of your loan. Variable-rate loans are based on the prime rate, meaning when the prime rate changes, so will your interest rate.
Variable rates are generally advertised as prime rate plus/minus the interest rate (ex: prime rate + 1.5%). How much the rate changes throughout the loan will depend on the current conditions of the market.
| How Often Does The Prime Rate Change? The prime rate doesn’t follow a fixed schedule, it changes in response to shifts in the Bank of Canada’s policy interest rate. When the Bank of Canada raises or lowers its policy rate, lenders typically adjust their prime rate accordingly. For example, between January 2015 and January 2020, the prime rate changed 7 times. However, from January 2020 to January 2025, it changed 19 times. This sharp increase was likely driven by the COVID-19 pandemic which caused major economic disruptions. |
What’s Better? Fixed-Rate vs. Variable-Rate
Depending on your financial situation, one option will be better suited to you than the other.
When Are Fixed Rates Better?
Fixed rates are preferred by many individuals because they offer more security and stability than loans with a variable interest rate. Loans with fixed rates are easier to budget around as payments stay the same. If you’re on a tight budget, a fixed rate would offer the most security.
Fixed-Rate Drawbacks
- You’re Locked In: The main downside of fixed interest rates is that you’re locked in for the entire term of the loan. Meaning, if the BOC cuts rates during your term, you can’t benefit from the lower rates unless you break your contaract early and refinance. However, doing this generally comes with penalty fees which can eat away at your savings.
- Fixed Rates Start Higher: Compared to variable-rate loans, fixed-rate loans often come with a higher starting interest rate. Lenders charge more for the stability and predictability of a fixed rate. This means your monthly payments may be higher from the beginning, even if interest rates don’t rise in the future. In contrast, variable-rate loans can offer lower initial payments, at least for the first few years, which can be appealing if you’re looking to save money in the short term.
When Are Variable Rates Better?
Variables rates are generally best for individuals who can tolerate more risk, as rates fluctuate with the prime rate. If you believe rates are going decline, a variable can be a good choice. Moreover, historically, variable rates for mortgages have often been lower than fixed rates.
Variable rate loans are usually more flexible and may contain extra features and benefits. For example, variable-rate mortgages tend to have less costly penalties for breaking a contract.
Variable-Rate Drawbacks
- Payment Can Fluctuate: The interest you pay with each payment can vary from month to month depending on the prime rate.
- May Need Monitoring: Depending on the type of payment structure you have, you may need to monitor your rate more often to better budget.
What Types Of Loans Can You Get A Variable Rate?
As a credit user in Canada, there are several variable-rate loans you can find, such as:
Mortgages
Mortgages are the most common type of loan that offer variable rates. In the case of a variable-rate mortgage, your interest rate will fluctuate according to Canada’s prime rate.
There are two types of variable rate mortgage payments, and depending on which one you have, it can impact your payment.
Adjustable Payments With A Variable Rate
With this payment method, your payment amount can increase or decrease based on the prime rate. However, the amount that goes to principal is the same, only the interest portion changes. For example, if the prime rate goes up, the mortgage principal payment will stay the same, but the overall payment amount will increase to cover the increase in interest.
Fixed Payments With A Variable Rate
With a fixed payment structure, the ratio between how much of your payment goes towards the principal and interest will change based on the prime rate. If the prime rates rises, a larger portion of you payments will go toward paying the interest. Similarly, if the prime rate reduces, a larger portion of the payment will go toward the principal.
Personal Lines Of Credit
A personal line of credit allows you to borrow money from a predetermined limit. You can use the money for any expense and spend as much as you need, up to that limit. As you repay the amount borrowed, you regain access to the money without having to reapply.
Generally, personal lines of credit feature a variable interest rate. You’re only required to pay the minimum amount, which can be just the interest portion of the payments. However, you’re free to pay back the principal amount at anytime.
What Types Of Loans Can You Get A Fixed Rate?
In Canada, you may come across many kinds of fixed-rate loans too, including:
Personal Loans
Personal loans are basic installment loans and come with a fixed rate. With this loan, you’ll receive a lump sum of cash that you repay in regular installments (usually monthly) over a period of time. This makes personal loans easy to budget for.
Do note that that many personal loans don’t allow prepayment without a penalty, so check your terms carefully if flexibility is important to you.
Mortgages
You can get a mortgage with a fixed rate from banks, credit unions and private lenders. Mortgages with a fixed rate come with predictable payments and are not affected by changes in the market. This makes makes them a popular choice for many borrowers who want consistency and peace of mind.
Car Loans
Car loans commonly come with fixed rates. Payments are made in installments over 12 – 96 months. This predictability makes car loans easier to manage and budget for, especially when you opt for a longer term to reduce monthly payments. You can typically apply for a fixed rate through your bank, credit union, online lender or vehicle dealership. To get the best rate, it’s best to get pre-approved and compare multiple quotes before applying.
Credit Cards
Credit cards come with a high fixed interest rate. Interest rates usually range around 21.99%, though some creditors may offer lower interest rates. With credit cards, you’ll have a grace period of about 21 days; after that, you’ll be charged interest on your balance. Credit cards are generally a good option for small purchases.
Should You Use A Variable Rate Loan Or A Fixed Rate Loan?
It’s hard to predict economic changes, especially in the long term. As such, a variable rate is generally a good option when choosing a shorter term and rates are low. That said, here are some key factors to consider when choosing between fixed-rate vs. variable-rate loans:
- Interest Rate Trend – If Canada’s prime rate is forecasted to increase, applying for a fixed rate may be a safer choice, depending on how high it is. On the other hand, a short payment term with a low variable rate is far better when rates drop.
- Personal Financial Situation – While you may enjoy low rates with a variable rate, you also need to ensure your budget is flexible enough to comfortable handle an interest rate increases. This is particularly true if you have a variable mortgage with an adjustable payments. If you’re on a tight budget, a fixed rate or a variable rate with fixed payments will likely be the best option.
Bottom Line
Whichever you decide to go with, you should ensure you put a lot of thought into it. Just remember, a loan is a helpful tool, but it can also lead to unmanageable debt if not used responsibly. Ensure your loan payments are well within your means. Before you apply for any loan, it is a good idea to do some research and take a step back to ensure you are making a good choice based on your current financial situation and needs.
