If you are looking to renew your current mortgage, or you are a first-time home buyer, you likely already know just how many little details need to be sorted out before deciding on what kind of mortgage you will end up getting. One consideration is whether you should get a fixed-rate or variable-rate mortgage. If you’ve ever seen an ad for mortgage rates, you’ll notice that the rate is often shown in VERY LARGE numbers, but the word “fixed” or “variable” is often in very tiny fine print. Don’t assume it means that it’s not important because whichever one you choose could have a big impact on what you’ll end up paying over time.
Learning about prime rates and the Bank of Canada
Mortgage rates are directly related to what is happening with the Bank of Canada – as it sets the prime interest rates for the country. These rates can go up and down depending on inflation and what’s happening around Canada, such as unemployment rates, oil prices, consumer debt, and even significant events in other countries that we do business with. Over the past several years, these rates have been fairly stable with no major surprises, which is great for everyone who borrows money because interest rates have stayed the lowest they have been in a very long while. This is also great for our economy. Some financial experts are confident that a large and sudden hike in rates won’t be happening anytime soon, but when it comes to interest rates, no one can predict for certain what will happen. We can however, learn more about this field and how it affects our personal financial needs. For now, let’s look into fixed and variable rates, as well as the benefits and drawbacks of each.
What exactly is the big appeal with a fixed-rate mortgage?
A fixed-rate mortgage is where the interest rate stays the same for a set period of time – usually between 1 and 5 years. With a fixed rate, you pay the same amount each and every payment (this includes interest plus principal) for the term of your mortgage. This is all calculated when you set up your mortgage, and during the length of your term you will have no surprises – even when rates go up or down for others, yours is locked in and the lender can’t change it. When interest rates are low like they are these days, this type of mortgage is very appealing – as it can feel very secure and satisfying knowing exactly how much you are paying towards your principal and interest, and it’s easy to understand. In fact, in Canada, more people opt for a fixed mortgage than a variable mortgage. One downside to a fixed-rate mortgage is that the interest rate is higher than variable-rate mortgages. The lenders do this intentionally in case the rates do go up, as it gives them a bit more financial protection. Also, when you have a fixed-rate mortgage, you agree to stick with it for the full length of the term, and if you want to get out of your mortgage, or “break” it, you will have to pay penalties. One thing to note is that even if the interest on fixed-rate mortgages goes up in the next while, it is still lower than it was five years ago. So, anyone in Canada who has a mortgage coming up for renewal may be delighted to find that their new rate is lower than what they signed up for previously.
So how does this compare to a variable-rate mortgage?
Variable interest rates move up and down along with prime rates or market interest rates (which reflect whatever rate the Bank of Canada has set). This all means that if you choose a variable-rate mortgage, your interest payments will go up or down too, depending on what the Bank of Canada does and how your lender reacts to changes in their rates. You’ll notice that interest rates on this type of mortgage are lower than the fixed-rate mortgages because of the potential risk involved – as mentioned before, we just don’t know what will happen with our economy, or what the Bank of Canada will do. They could hike interest rates overnight and you will suddenly pay more interest. This doesn’t necessarily mean that your payments will skyrocket and you’ll need a second or third job, but it would result in you paying off more interest every payment than actually paying off your principal (which is the original amount of money borrowed before interest). The good news is, when interest rates go down, you see the benefits – and will end up paying more off your principal and thus speeding up the amortization! It’s also cheaper to break a variable-rate mortgage, as the penalty is usually only three month’s interest payment, and, most lenders will allow you convert over to a fixed mortgage during the term. This type of mortgage is great for people who are willing to take some risks, but you already have a ton of debt, you likely can’t afford a surprise increase. If you do choose a variable-rate mortgage, you need to ensure you can handle a rate increase.
Although we can’t control the ever-changing real estate market or what the Bank of Canada decides to do about interest rates, we can get informed and understand the various trends – which is exactly what I do as a Mortgage Broker. The best mortgage plan is developed by carefully assessing your financial situation and finding out what type of risk you can manage. If you have any questions about your current mortgage or are looking to buy your first home, give me a call at 705-315-0516. I am always happy to help you better understand and plan for your financial future.