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The age-old question…do I go variable or fixed? 

Fixed mortgage rates are more popular and represent about 70% of all mortgages in Canada. With a fixed rate mortgage, you can “set it and forget it” as you are protected against interest rate fluctuations, so your payment stays constant over the duration of your term.

Historically variable mortgage rates are typically lower than fixed rates, but can vary over the duration of the term. Variable mortgages are prone to market behaviour (via the prime rate) which affects your payments. That means your payment amounts can change over the term. A fixed mortgage offers stability as your mortgage rate and payment will remain the same each month, but that security is the reason why fixed interest rates are historically higher.

With a fixed rate mortgage, the mortgage rate and payment you make each month will stay constant for the term of your mortgage. With a variable rate mortgage, the mortgage rate will change with the prime lending rate, as set by your lender. A variable rate will be quoted as Prime +/- a specified adjustment, such a Prime – 0.700%. Though the prime lending rate may fluctuate, the relationship to prime will stay constant over your term. For example, a variable rate could be quoted as prime – 0.700%. So, when the prime rate is, say, 3.950%, you will pay 3.250% (3.950%-0.700%) interest.

All borrowers must pass the current stress test.  Variable rate mortgages must qualify based on the posted Chartered Bank Benchmark rate (currently 5.19%).  While Fixed rate mortgages are stressed at either the Benchmark rate or the actual rate plus 2%, whichever is higher.  This means that if fixed rates are greater than 2% below the current benchmark rate, you could potentially qualify for a higher mortgage with a variable rate.

The prime lending rate is dependent on the state of the current economy, which is determined by economic factors like inflation and unemployment. When the inflation rate is high, then the Bank of Canada will make increases to the overnight rate which will make borrowing money more expensive. When the inflation is lower, the prime rate will be decreased in order to stimulate and improve the economy as well the appeal for borrowing.  Make note that the prime lending rate is set by each lender and therefore may not be the same at all banks/institutions.  They are based on the Bank of Canada Target Overnight Rate.

–So how do you choose? 
One of the quickest ways to determine if a variable-rate mortgage product is right for you is whether or not you can afford payment increases.  The first thing you should assess is your current income and potential for fluctuations in your income.  Can you handle payment increases?  If you can comfortably afford mortgage rates that are two per cent higher than what you’d pay on your variable, then you may be OK.  But proceed with caution.  Rates right now are at historic lows.  So low that it’s quite conceivable you could see rates double before your term is up.

Understanding the risk involved is a prerequisite.  If you’ve decided you can afford a variable-rate mortgage, the next thing you will want to determine is if a variable-rate mortgage fits your personality.  If you’re the type of person who can’t sleep at night knowing your rate/payment may go up, even slightly, a variable-rate mortgage may not be the best option for you.

Another thing to consider is your future plans or even the unexpected.  With a variable rate mortgage, you will only pay 3 months interest penalty to break your mortgage early.  With a fixed rate you will pay the higher of the interest rate differential and 3 months interest.

For a detailed explanation of how Interest Rate Differential is calculated, refer to our previous blog from September of 2015 called “No Two Penalties are Created Equal”.  The interest rates have changed but the calculation is just the same.

Contact us to review your best options.