Variable vs. Fixed Mortgage Rates

A question many homebuyers are often conflicted about when buying a house is whether they should opt for a fixed vs variable mortgage. Depending on your financial circumstances and risk tolerance, one will inevitably be better and more affordable for you. Below, we’ll explain the differences between the two to help you make a more informed decision.

Key Points

• A fixed-rate mortgage is one in which the interest rate remains unchanged throughout the mortgage term.
• A variable-rate mortgage is one in which the interest rate fluctuates along with the prime rate.
• Fixed-rate mortgages may be better suited for those who prefer more stability with their mortgage payments.
• Variable-rate mortgages may be better if rates are expected to dip or for those who want more flexibility in their loan terms.

What Is A Fixed-Rate Mortgage? 

Under a fixed-rate mortgage, your payment amounts do not change over the length of the loan term. Your payments go toward paying off the principal and interest combined. 

Although each payment remains the same every month, the percentage of each payment that goes toward paying off the principal versus interest changes. As you pay down your mortgage, a larger portion of your payments will go towards the principal, and a smaller share will go towards the interest. 

To demonstrate this change in payments, below is a partial amortization table of a 5-year, fixed-rate mortgage of $300,000 with a 30-year amortization and an interest rate of 4.2%. 

How Is A Fixed-Rate Determined?

Fixed mortgage rates are determined based on the prime rate and the economic climate at the moment your loan contract is created. Therefore, the interest rate during your term will always remain the same, regardless of how the economy and prime rate are doing a few years later.

In general, banks and lenders base their rates on the Bank of Canada benchmark rate. Banks and lenders must adhere to this rate when qualifying borrowers for mortgages in Canada. 

The reason for this is that the government wants to make sure people will be able to handle any market volatility. So, often you will find that the benchmark rate is about 1.5% higher than the best rates in the market.  

Find The Best Mortgage For Your Needs

	Amount	Rate	Availability	Products
Loans Canada	Varies	Varies	All of Canada	- First mortgage - Refinancing - Renewal - Lender switch - Home equity loans
Alpine Credits	$10,000+	Based on equity	All of Canada except Quebec	- Home equity loans
Mortgage Maestro	$10,000+	5.19%+	All of Canada except Quebec	- First mortgage - Refinancing - Renewal - Line of credit (HELOC) - Reverse mortgage
Neo Mortage™	Varies	5.54%+	All of Canada except Quebec	- First mortgage - Refinancing - Renewal
nesto	$100,000+	5.34%+	All of Canada	- First mortgage - Refinancing - Renewal
Homewise	Varies	Varies	BC, AB, MB ON	- First mortgage - Refinancing - Renewal - Lender switch
Fairstone	$5,000 $60,000*	19.99% to 25.99%	All of Canada	- Home equity loans

Pros And Cons Of A Fixed-Rate Mortgage 

Though the cost of borrowing a mortgage on a fixed rate tends to be a little higher than borrowing on a variable rate, there are still several advantages. 

Pros 

• Stable payments. Fixed-rate mortgages mean your monthly payments will remain unchanged throughout the loan term. This makes these bill payments more predictable and easier to budget. 
• Your rate is set. Throughout your mortgage term, your interest rate will remain the same. There’s no concern about your rate changing at any point until it’s time to renew. Any increases in interest rates won’t affect you. If rates skyrocket, you’ll be protected.

Cons

• May be more expensive. Though a fixed rate is a less risky option, it can cost more in terms of interest. That’s because these mortgages typically come with a premium in exchange for their stability. So, you may be paying more in interest over the life of the loan.
• You may miss out on rate decreases. If interest rates dip during your mortgage term, you won’t be able to simply back out of your term to secure a lower rate. You’re locked in until your term ends unless you break your mortgage early and pay a penalty fee for doing so. 

What Is A Variable Rate Mortgage? 

A variable rate mortgage varies and changes with the prime rate. When the prime rate is adjusted based on economic factors, the variable rate on your mortgage loan will be adjusted as well. Therefore, your payments or the interest portion can be constantly changing based on economic factors.

How Is A Variable Rate Mortgage Determined? 

The variable rate is determined using the prime rate of Canada. It fluctuates with the prime rate and will change periodically. 

The prime rate is an interest rate that major banks and financial institutions use as a measure to set their rates for different credit products. It is influenced by the overnight rate set by the Bank of Canada, which is shaped by the cost of borrowing for the major financial institutions in Canada. 

Often, rates will be advertised as the prime rate minus a certain percentage. For instance, if the prime rate is currently 5.95% and the bank’s discount rate is 1.2%, this translates to 5.95% – 1.20% = 4.75% (your interest rate).

Types Of Variable-Rate Mortgages

There are two types of variable-rate mortgages: 

Adjustable Payments With A Variable Rate 

With this type of arrangement, the amount that goes towards the principal remains the same, even if rates change. However, the amount that goes toward the interest will change if rates fluctuate. Therefore, your payments will increase or decrease as rates change, which is perhaps the biggest risk for those who are on a tight budget or have less predictable income.

Fixed Payments With A Variable Rate 

In this case, the portion of the payment going toward interest will change as the rate changes. So, if rates increase, so will the amount paid toward interest, which means it will take longer to pay down the principal. On the other hand, if rates decrease, a smaller amount of your payments will go toward interest. 

With this option, your mortgage payments stay the same, no matter what changes occur with interest rates. This option is best for those who prefer stability with their mortgage payments while still hoping to speculate on and benefit from falling rates. However, there is an exception to this rule:

Trigger Point  

If the market interest rates increase to a certain level — referred to as the “trigger point” — your payments may increase to cover the interest. This is done to make sure that your mortgage is paid off by the end of the amortization period. 

Pros And Cons Of A Variable Mortgage Rate

Variable rate mortgages offer a handful of perks, but they also come with some drawbacks to consider. 

Pros

• More affordable when the prime rate dips. If you go with the variable rate, you stand to save more money compared to a fixed rate. Depending on what’s happening with the prime rate from the central bank. As the prime rate lowers, the interest rate on your mortgage decreases. In this case, more money can go toward paying off the principal. 
• More flexibility. You may be able to switch to a fixed rate at any time during your loan term without being charged a penalty fee.

Cons

• More expensive when the prime rate increases. If the prime rate goes up, the interest rate on your mortgage will increase as well. 
• More difficulty budgeting if rates increase. If rates increase, your mortgage payment could change (if you choose an open variable-rate mortgage), which can make your mortgage payments less predictable and more difficult to manage.

Which Loan Rate Do I Choose? 

When deciding between a variable and fixed-rate mortgage, you must consider a number of personal and economic factors to see which of the two works best for you. 

Choose a variable-rate mortgage if … 

• Rates are expected to fall over the near future.
• You can handle fluctuations in mortgage payments.
• You may potentially sell your home in the near future.

Choose a fixed-rate mortgage if …

• Interest rates are fairly low, and you don’t expect it to fall further during your loan term.
• You prefer more financial certainty and stability.
• You plan to stay in your home for years to come.

Pro Tip: Lock Your Rate In Advance When It’s Time To Renew

One of the best strategies you can take on is to lock down a mortgage rate well before the mortgage term ends. This can protect you from a short-term rate increase and will let you evaluate which term is right for your next mortgage cycle early on. Many lending institutions now provide rate-locks of 3, 4 and up to even 6 months – so taking advantage of this is a no-brainer.

Additional Reading

The 3 Main Factors Influencing The Bank of Canada’s Interest Rates

Bank Of Canada Lowers Interest Rates: What It Means For Fixed And Variable Mortgage Rates

Why Lower Interest Rates Won’t Solve The Housing Crisis: Root Cause Is Supply Shortage

Bottom Line

Whatever rate you choose should work well with your financial lifestyle and economic factors. If rates are expected to fall and you have an appetite for risk, then a variable rate mortgage could be the way to go. If you are risk-averse and prefer to make the same payments every month, then stick to a fixed-rate mortgage. In the end, whether you go for a fixed vs. variable mortgage, your bank will be able to help you choose what suits you best.

Variable vs Fixed Rate Mortgages FAQs

Note: Loans Canada does not arrange, underwrite or broker mortgages. We are a simple referral service.