![\"\"](\"https:\/\/www.livabl.com\/articles\/wp-content\/uploads\/2019\/05\/fixed-and-variable-rate-mortgages-2.jpg\")
<\/a>Photo: James Bombales<\/em><\/p>\nLet\u2019s start with the basics. What\u2019s the difference between a fixed- and variable-rate mortgage?<\/h2>\n
With a fixed-rate mortgage, you agree to pay a set interest rate for the predetermined \u2018term\u2019 \u2014 the length of time you commit to the interest rate, lender and associated conditions of your mortgage product. The most common term length is five years but they can range from six months to 10 years.<\/p>\n\n
For example, a bank quotes you an interest rate of 3.5 percent for a five-year term, on a $500,000 loan, amortized over 25 years. With a fixed-rate mortgage, you will pay 3.5 percent interest on your monthly mortgage payments until the five-year term is up and you inevitably have to shop around for a new mortgage product \u2014 either with your current lender or somewhere else. \u201cFixed is going to be your rate for the entire term of your mortgage, it’s not going to change at all,\u201d explains Okun.<\/p>\n
Variable-rate mortgages are a bit more complicated because your monthly interest rate can fluctuate from month-to-month, based on what\u2019s happening with the economy. Variable mortgages are appealing because historically they lead to more savings over time than a fixed mortgage. The drawback is the risk involved because your monthly mortgage payments can change dramatically without warning.<\/p>\n
Variable-rate mortgages are influenced by short-term rates, while fixed-rate mortgages are based on longer-term rates. The central bank looks at a host of economic factors and sets a benchmark interest rate that lenders can offer clients with variable mortgages. This interest rate moves in tandem with the Bank of Canada\u2019s overnight lending rate which changes eight times a year and influences the prime rate. If prime goes down, your interest rate will go down. If prime goes up, you\u2019re paying more that month.<\/p>\n
In addition to looking at the prime rate, your lender will offer you an additional discount on your interest rate that will be true for the entire term of your mortgage.<\/p>\n \u201cWhen you get a variable rate, you\u2019re getting a discount,\u201d says Okun. \u201cIt could be prime minus 95, prime minus 35, prime minus 1.05, etc. And that discount is true for the life of your mortgage but as prime fluctuates so will your rate.\u201d<\/p>\n At the time of writing, prime is at 3.95 percent. If prime went up to 4.0 percent and you have a discount of 80, you will pay 3.20 percent interest. If prime went down to 3.80 percent, your discount would bring you to three percent.<\/p>\n The discount available to you will vary based on the lender you go with and the mortgage products available to you. Are you putting down less than 20 percent and defaulting to an insured mortgage and CMHC insurance? Are you refinancing your mortgage? Is it for your primary or secondary home? Are you going with a bank or a mortgage agent? All of these factors and more will impact the discounts you have access to.<\/p>\n The majority of Okun\u2019s clients go for a fixed mortgage.<\/p>\n \u201cMost people are a bit more risk averse, especially first-time homebuyers,\u201d says Okun. \u201cIt’s their first time trying it out and they want the stability of knowing that they’re going to have the same payment every month.\u201d<\/p>\n Okun notices that people who are a bit more seasoned are more likely to take a variable mortgage. \u201cPeople who have had a mortgage before and are into their second or third renewal \u2014 they might be more willing to try variable having watched the market and seen where they could save money.\u201d<\/p>\n Okun estimates that a third of her clients go for variable, which mirrors the results from the 2018 Annual State of the Residential Mortgage Market in Canada study by Mortgage Professionals Canada where 30 percent of mortgages purchased in 2018 had a variable rate.<\/p>\n We\u2019ve been in an environment of rising interest rates since the summer of 2017. Between then and October of last year, the Bank of Canada hiked the overnight rate five times, in response to the weakened energy sector. \u201cWhen we were seeing prime go up, that was stressful for people who had variable rates,\u201d says Okun. \u201cThat said, it really depends on the discount you\u2019re getting with your variable rate. Now, I\u2019m seeing rates that are prime minus 1.05.\u201d<\/p>\n Sometimes banks will promote very attractive fixed rates for short terms (one- to two-year). You might find lower interest rates than a five-year variable mortgage, but Okun advises to steer clear. \u201cIt\u2019s most profitable to banks to have you roll over into a new product more often. Sometimes people think they\u2019re getting some kind of security on that two-year fixed rate, similar to the discount that they would get on a variable rate. But if you are looking to save money, you are, generally speaking, better off on a five-year variable product than you are with a two-year fixed.\u201d<\/p>\n To help her clients decide, Okun sets up a scenario where she compares the monthly payments of a fixed-rate mortgage against hypothetical increases on a variable mortgage.<\/p>\n Okun begins by mapping out your monthly payments each month for the next five years with a fixed mortgage. This part is pretty simple, since it\u2019s the same every month. If you go with variable, she will outline your payment for the first six months based on the prime rate and your discount, then increase prime by five basis points every six months until the end of your term, demonstrating what you\u2019d pay each month.<\/p>\n Let\u2019s say at the outset, you have a variable mortgage and are saving $600 a month. Then prime goes up and you\u2019re saving $400 a month. \u201cUsually two and a half years in, you get to the break even point,\u201d says Okun.<\/p>\n But keep in mind, in the first two years, your first mortgage payments will be interest-heavy. As your loan\u2019s principal goes down over the years with more payments, so too does the interest you\u2019ll pay on it. \u201cFor the last two and a half years of your term, you might lose money with variable. But it\u2019s on a declining balance, so you\u2019re losing less than you would have at the outset. At the end of five years, maybe you\u2019ll still come out $1,000 ahead.\u201d<\/p>\n If you have a large discount on prime, this is a no brainer. \u201cBut if your discount on prime is only 35 basis points, the savings are going to be so minimal, it probably won\u2019t be worth it,\u201d says Okun.<\/p>\n<\/a>Photo:\u00a0Jonathan Petersson<\/a>\u00a0on\u00a0Unsplash<\/a><\/em><\/p>\nWith a variable-rate mortgage, you will also get a discount on prime.<\/h2>\n
<\/a>Photo: James Bombales\u00a0<\/em><\/p>\nWhat\u2019s the most popular choice?<\/h2>\n
<\/a>Photo: James Bombales<\/em><\/p>\nHow do you decide?<\/h2>\n