Variable versus Fixed

If you have recently been pre-approved for a new mortgage, or received a renewal notice from your current mortgage lender, you are likely experiencing some sticker shock. Yes, rates are higher now which can be daunting.

Choosing a variable rate mortgage can be a strategy to ride out higher interest rates. Some clients are choosing to go variable these days with the hope that these high rates don't last too long and that rates come down, eventually.

How does a variable work?

A variable rate mortgage has a fluctuating interest rate. Your interest rate is based of off of the prime lending rate and is often shown as the prime rate plus or minus a number. As an example, you will sometimes see a rate of prime -1.00% or prime +0.50%. The term is often 5 years long, though some lenders offer shorter variable term mortgages. If you had a variable rate mortgage at Prime -1.00% on a 5-year term this would mean that for 5 years your rate will be whatever the prime interest rate is minus 1.00%. 

Who sets the prime rate?

The prime rate is set by the Bank of Canada which makes an interest rate announcement, eight times a year, on pre-scheduled dates. The dates are published at the beginning of the year so you will know when to expect an interest rate announcement. You can see the schedule HERE.

Clients often ask me if the Bank of Canada announcements affect fixed-rate mortgages and the answer is no; fixed-rate mortgage rates are based on the 5-year bond yields. That being said, they do often trend in a similar direction. You can view the history of the 5-year bond yields HERE. 

One thing to keep in mind; just because the Bank of Canada has a scheduled interest rate announcement, doesn’t necessarily mean that they will change the rate. It only means that they will announce whether it will stay the same, increase, or decrease. Prior to the pandemic, we had several years with absolutely no change to the prime rate at all. Conversely, when the pandemic began, the Bank of Canada slashed the prime rate. In recent tyears the prime rate increased substantially due to high inflation. We now appear to be on a downward rate trajectory.

What are the potential benefits of a variable rate mortgage?

Ability to convert:  One nice feature of a variable rate mortgage is that you usually have the option of converting to a fixed-rate mortgage at any time within your term (without a penalty) so you could keep your eye on rates and convert to a fixed-rate mortgage if rates do come down, eventually. 

Low payout penalty: Another redeeming feature of a variable rate mortgage is that, if you ever needed to pay the mortgage off within your term, the penalty is a simple three-month interest penalty. I really like the flexibility that it offers, especially if you own a property that you might sell in the near term.

What are the potential cons of a variable rate mortgage?

No cap to rate increases: The big, potential con of a variable rate mortgage is that there is no cap to the prime rate and you don’t know how high it will go. So, that is a definite risk that you’d have to weigh. Variable rate mortgage holders saw their rates rise substantially in 2022. But conversely, the rate has decreased several times in 2024! 

Often no portability: depending on your lender, you may not be able to port your variable rate mortgage to a new property if you move. So, you could end up having to pay a three-month interest penalty if you decide to move while you are in the middle of your mortgage term. Fixed rate mortgages are typically portable so you can move your mortgage to a new property without paying a penalty, 

I’ve written this to give you a quick breakdown of the potential pros and cons of choosing a variable rate mortgage. It is ultimately a very personal decision and often lies with how comfortable you are with uncertainty as well as risk/reward. With a fixed rate mortgage, you will know what your payment and interest rate will be for your entire mortgage term but could end up paying more than you need to if rates decrease within your term. With a variable rate mortgage, you could be open to a great deal of fluctuation throughout your term and while this is not for everyone, you could be rewarded with lower rates throughout your term as well as having the ability to convert to a fixed term mortgage at any time. The decision to go variable or fixed can be tough right now but I am happy to help you weigh your options.

Please reach out to me to discuss your individual circumstances in more detail!