Fixed vs Variable Rate Mortgages in Canada: What Are the Differences?

Choosing between fixed and variable mortgages is a decision that will affect you for many years to come, so it’s best to take your time to understand the pros and cons of each option. Making the right choice can help you save money in the long term and meet your goals. In this article, we will look at fixed vs variable rate mortgages in greater detail.

What Is A Fixed Rate Mortgage?

These are loans whose interest rate remains the same for term of the loan. In other words, this type of mortgage has a constant interest rate.

No matter what happens with interest rates in the economy, the interest rate of a fixed rate mortgage stays constant.

When you take a fixed rate mortgage, you know how much of your mortgage payment will go toward paying off the principal and how much will go toward paying off interest for the term of your mortgage.

According to the Mortgage Professionals Canada (MPC), a majority of borrowers in Canada choose fixed rate mortgages and it’s easy to see why. Many homebuyers in Canada opt for fixed rate mortgages because they allow them to plan their payments. However, there are drawbacks to this option which you’ll want to consider.

Here’s an example of how a fixed rate mortgage works

A mortgage lender offers an annual percentage rate of 2% and a set term on a $450,000 loan, which will be paid back over 30 years. The interest rate for the mortgage will stay at 2% no matter what happen with the economy.

What Is A Variable Rate Mortgage?

Variable rate mortgage refers to loans whose interest rates fluctuate over time based on changes in the market.

The prime rate in Canada is influenced by the overnight rate set by the Bank of Canada. This means interest rates for variable rate mortgages can fluctuate as often as every month, depending on the rates set by the Bank of Canada.

Variable rate mortgages provide borrowers with the flexibility to leverage falling interest rates. However, rising interest rates can significantly increase the cost of borrowing, so it’s important that you understand the potential for elevated mortgage costs before you opt for a variable rate mortgage.

How Fixed Rate Mortgages Work

As we have already mentioned, the interest rates for fixed mortgages in Canada remain the same over the term of the mortgage, regardless of the prevailing economic factors and prime lending rate. Interest rates for these loans are determined based on the economic climate and prime rate at the time the mortgage contract is created. Also, interest rates for fixed mortgages follow the pattern of the bond market. If you prefer making predictable payments every month, then a fixed rate mortgage might be an ideal option for you.   

How Variable Rate Mortgages Work

Variable rate mortgages fluctuate based on the prime lending rate, which is an interest rate that banks and financial institutions use to lend different credit products to their most trusted customers. When rates on a variable mortgage reduce, more of your payment goes towards paying off your principal; if the rates increase, more of your payment goes towards paying off your interest.

Pros Of Fixed Rate Mortgages

1. Interest rate does not change over time

Fixed rate mortgages’ interest rate do not change for the duration of the loan, regardless of what happens with the economy or interest rates. This advantage brings about certainty and peace of mind because an increase in interest rates won’t affect you.

2. Knowing the cost of your mortgage can really help with budgeting

Fixed rate mortgages ease budgeting anxiety as you know exactly what you’re going to pay every month for a fixed period of time. This is one area where fixed rate mortgages score higher than variable rate mortgages, which can disrupt your budget in case interest rates go up.  If you have to adhere to a strict budget, fixed rate mortgages can be good for you.

3. You can great fixed-term deals if you take your time to shop around

Mortgage lenders in Canada compete on the interest rates they offer on fixed rate mortgages, so you can get some great deals. Ensure you shop around and compare several fixed rate mortgage offers. This can save you thousands of dollars down the road.

Disadvantages Of Fixed Rate Mortgages

1. More expensive in terms of interest

A fixed rate mortgage has a higher interest compared to a variable rate mortgage. The longer the repayment term, the more expensive the mortgage will be.

2. You may not be able to make additional repayments beyond a certain limit

Fixed rate mortgages usually cap the additional repayments you can make. You may face significant penalties if you exceed the allowed limit. But with a variable rate mortgage, you can make extra repayments and pay off your mortgage as quickly as you could.     

3. You won’t benefit when interest rates go down

Since fixed rate mortgages are inflexible regardless of what’s happening with the economy or prime lending rate, you’ll pay the same interest rate even when interest rates drop. It’s only borrowers with variable rate mortgages who will benefit when interest rates fall.

4. Not a good option if you might need to move sooner than expected

If you have plans to move after 2 years and you took a 5-year fixed rate, you may have to sell your home within your mortgage term, which could attract expensive break fees.

5. Less flexibility

Fixed rate mortgages are inflexible in nature. Lenders cap additional repayments at a certain amount, denying borrowers the ability to make extra repayments to pay off their loans faster. It may also be more difficult to refinance a fixed rate mortgage. This inflexible nature can be inconvenient when you want to refinance your loan or pay off your loan faster.

Advantages Of Variable Rate Mortgages

1. Lower interest rate

Variable rate home loans often have lower interest rates compared to fixed-rate mortgages because mortgage lenders are able to transfer some of the risk to the borrower. While interest rates for variable rate mortgages may only be lower by 0.5% or less, you could save a lot of money when you multiply that by hundreds of thousands of dollars.  A variable mortgage can be a good option if you predict interest rates will drop. However, keep in mind that interest rates for variable rate loans can be adjusted upward depending on the prime lending rate and the economic climate.

2. You can save more money if interest rates drop

If the prime lending rate reduces, the interest rate on your variable mortgage goes down as well. That means more of your repayments will be applied to paying off the principal, thereby reducing your interest.

3. You may benefit from offset accounts and redraw facilities

These loan features can help you pay off your loan faster. Offset accounts can save you a significant amount of interest while maintaining an available redraw balance can reduce interest on your mortgage. Fixed rate mortgages do not offer these loan features, so if you intend to benefit from offset accounts and redraw facilities, you’ll want to consider taking a variable rate mortgage.

4. More flexibility

Variable rate mortgages offer more repayment options, including the ability to make extra repayments without attracting penalties. Borrowers with a fluctuating income can make lump sum payments and benefit from lower monthly payments.

5. It is simpler to switch to a fixed rate mortgage

Most mortgage lenders in Canada allow borrowers to switch from variable mortgages to fixed mortgages, whereas a fixed rate mortgage cannot be converted to a variable rate mortgage. If you find that it’s best to switch to a fixed rate mortgage at some point for whatever reasons, you can generally do so without attracting hefty penalties.

Moreover, a variable rate mortgage doesn’t lock you into a contract which means you can easily refinance your home loan if you find a better deal with another lender.

6. If you break your variable rate mortgage, the penalty is typically lower

If you break a fixed rate mortgage, you could face steep penalties, but penalties for breaking a variable rate mortgage are much lower.

Disadvantages Of Variable Rate Mortgages

1. Interest rates can rise over time

Mortgage lenders can adjust interest rates upwards if the prime rate goes up. That means your repayments will increase when interest rates go up. This can not only cause uncertainty but can also make budgeting a challenge in the future. If you’re considering taking a variable rate mortgage, ensure you have the means to make higher repayments if interest rates increase.

2. Terms of variable rate mortgages can be confusing

These loans involve a lot of terminologies that can be confusing to borrowers who are new to mortgages. You’ll have to understand vocabularies like adjustment index, adjustment frequency, cap, ceiling, margin, and others. You may need to enlist the help of a mortgage expert to understand these terminologies so that you understand what you’re signing up for.

3. Cash flow uncertainty

Because interest rates for variable rate mortgages fluctuate based on prime lending rate and other factors, it becomes difficult for borrowers to predict cash flow over the long term. An increase in interest rates can disrupt your cash flow and put you in a state of uncertainty. But with the help of loan features such as offset accounts and redraw facilities, you can cushion yourself against unexpected events and pay off your loan quicker.

4. You’ll have to pay some fees if you break a variable rate mortgage

Although the penalty for breaking a variable rate mortgage is lower compared to breaking a fixed rate mortgage, you might still pay a break-up fee if you decide to terminate your mortgage contract before the end of its term.  


How To Choose Between Fixed-Rate Mortgage Vs Variable-Rate Mortgages

Choosing between fixed-rate mortgages vs variable-rate mortgages can be overwhelming, especially for first-time homebuyers. Here are some of the things you’ll want to consider when shopping for a mortgage in Canada.

1. Know how mortgage interest rates work

Knowing how mortgage interest rates work is key to choosing the best mortgage loan. It prevents you from choosing an expensive mortgage or making a bad choice that you’ll end up regretting later on.

2. How big is your down payment?

The bigger the down payment, the less you have to borrow and you’re more likely to qualify for lower mortgage rates. Besides, a higher down payment means you’ll get better rates.

3. Compare mortgage lenders

A majority of homebuyers in Canada do not take time to shop around and compare several mortgages before settling on the best deal. This is why some borrowers end up paying more than they should or breaking their mortgage contracts which leads to hefty penalties. Once you’ve assessed your mortgage needs and you’re sure about what you want, shop around and compare mortgages rates. Finally, make sure you know everything you need to know to choose a mortgage in Canada, as the wrong decision could cost you thousands of dollars.

Fixed Vs Variable Rate: The Bottom Line

Generally, choosing the right mortgage in Canada will depend on your financial health i.e. your income, credit score, and financial goals. Also, whether you choose a fixed or variable rate mortgage will come down to the following things:

  • The costs associated with changing your mortgage or refinancing
  • Whether you think you’ll want to make additional repayments in the future to pay off your loan faster..
  • Whether interest rates are predicted to go down or increase for an extended period of time.   

If you want to compare mortgage rates in Canada, here is a comparison tool that will help you compare various mortgage options. Instead of going with the first lender you come across, it’s best to compare various mortgage options in Canada to get the best interest rates.

Wondering if you should take a fixed-rate mortgage or a variable-rate mortgage? Take this short quiz to find out which is the ideal option for you.

Arthur Dubois is a personal finance writer at Hardbacon. Since relocating to Canada, he has successfully built his credit score from scratch and begun investing in the stock market. In addition to his work at Hardbacon, Arthur has contributed to Metro newspaper and several other publications