July 29, 2021

Hassan Amhaz – BDM & Mortgage Professional

It is the age-old question: should I choose a fixed or variable rate mortgage? Well, there is no straightforward answer as there are many factors to consider. 

Variable rates have a direct relationship with the Prime rates posted by banks, which are primarily influenced by the overnight rate set by the Bank of Canada. Fixed rates that banks and lenders offer are directly affected by what happens with Canadian Mortgage Bonds and their yields for those banks/lenders. There are certainly positives and negatives for both options, and ultimately the decision comes down to: the current state of the market & the economy, and individual preferences. 

What is the best option for you? Let’s break it down to help you answer that question.

Breaking Down Variable Rates

Positives: 

• Historically proven to be more cost effective over time
• Penalty for breaking mortgage term is always 3 months interest 

Negatives:

• Variable rates fluctuate over the course of your mortgage term
• May not offer the stability you prefer for your monthly budget

When you select a variable rate mortgage option, the rate is presented as Prime minus the discount rate associated with that product. A variable interest rate will change during the course of your mortgage term when your bank/lender’s prime rate changes. With some lenders, your payments will increase or decrease depending on the changes of their Prime rate. HOWEVER, there are lenders that will keep your payments the same to offer stability, with the only change being how much of your payment goes towards interest. When the Prime rate increases, more of your payment will be going towards the interest. If it decreases, then less of your payment will be paid as interest. 

Example

You approach Equitis Mortgage Group to assist in securing a mortgage for your property purchase. You decide that you would like to go for the variable rate option. The Prime rate the lender places you with is 2.45%*, and the discount rate they are offering on a 5 year variable term is 1.2%. This means your mortgage rate will be: Prime (2.45%) – 1.2% = 1.25%.

Now, if and when the Prime rate of your lender  increases to 2.6% (for example) 2 years into your mortgage term, your new interest rate will be: Prime (2.6%) – 1.2% = 1.4%. If and when the Prime rate of your lender decreases, then the interest rate you are paying on your mortgage will also decrease.

*The current Prime rate at most banks & lenders is 2.45%, and it is the lowest Prime rate on the market.

If at any point during your mortgage term you decide to switch lenders for a new mortgage rate option, sell your property, refinance to take out equity, or break your mortgage in any other way, you will need to pay a pre-payment penalty. With a variable rate mortgage option, your penalty will ALWAYS be 3 months interest.

What About Fixed Rate?

Positives: 

• Payments will remain the same throughout your mortgage term
• Offers stability to your monthly budget

Negatives:

• Potentially larger penalties with most banks & lenders
• May not be worth paying a higher price for stability
• Rates may go down during your term which you will not be able to access without a significant penalty

A fixed interest rate will not change during your mortgage term, which in turn means your payments will stay the same throughout the whole term. With respect to the penalty for breaking your mortgage before your term is up, the way it is calculated is different from a variable rate mortgage. How is the penalty calculated for fixed rate mortgages? It is either the Interest Rate Differential or 3 Months Interest, whichever one is GREATER.

Interest Rate Differential (IRD)

Most lenders will utilize 2 interest rates when calculating your IRD. The first interest rate is the current rate you have on your mortgage, and the second interest rate is the current posted rate for a term with a similar length to the remaining length of your current term. 

*Some banks/lenders will utilize the posted rate at the time of your mortgage and/or the discount rate you were originally offered. It is best to understand how your specific lender will calculate the IRD before you sign the mortgage commitment.

Example

Let’s assume the following:

• Outstanding Mortgage Balance: $500,000.00
• Current Interest Rate: 3.24%
• Number of Months Left in Term: 36 months left in a 60 month (5 Year) Term
• Current Posted Interest Rate for a Mortgage with a 36 month term offered by your lender: 2.24%

Your penalty will be the greater of 3 months interest or the IRD:

• 3 Month’s Interest = $3,733.33
• IRD = 3.24%-2.24% = 1.0% x 3 Years (remainder of the term) = 3% x $500,000.00 (mortgage balance) = $15,000.00

In this scenario, your penalty to break your mortgage term would be $15,000.00

Head to Head

As shown in the breakdown above, there are some key differences between fixed and variable rate options, with positives and negatives for both. If you have a strict monthly budget and do not want your payments fluctuating, fixed rate might be the best option for you. This option works great for individuals who want consistency and have no plans of making any changes to their mortgage for the term length they select. However, you never know what may happen and if you were to break your mortgage term early, your penalty could be significantly high! 

If you have short-term financial goals and could see yourself breaking your mortgage early, then a variable rate option is the better choice. This ensures that your pre-payment penalty will only be 3 months interest. In addition, variable rates are typically lower than fixed rates because you are undertaking part of the risk if the lender’s prime rates change. At the current time of writing this post, the rate on a 5 year fixed mortgage is 2.24% for a client putting a 20% downpayment, whereas the rate on a 5 year variable mortgage is 1.4%.

Give me a call or message directly at (778) 861-6462 if you have any questions about rate options, or if you would like to know more about what solutions you qualify for. Follow us on social for the latest updates and tips!