A common question I get asked is should I go with a variable rate mortgage or a fixed rate mortgage? The answer? Yes.

There is no one size fits all for the fixed vs variable and a lot of it comes down to current market conditions as well as one’s own risk tolerance. A small part of it is built into the potential difference in penalty fees, especially when debating staying in your current property long term or a move sooner than expected. Let’s jump into the features of both.

The Fixed Rate

This has been the most common type of mortgage I’ve seen since joining the industry some 6 years ago. It is especially common for first time home buyers, as they typically are committing a large majority of their financial resources to this big purchase! Here’s the basics:

·         Your rate will not change over your term! You can choose from 6 months to 10 year terms

·         Penalty fees are calculated at the greater of 3 months interest or IRD

·         Easy to predict your payments for long periods of time

·         More costly to take advantage of rate drops

·         Immune to rate increases

The Variable Rate

This rate is specifically tied to three things: The Bank of Canada overnight rate, bank prime lending rate, and typically a discount you receive from the bank prime. At the start of your term you are prescribed an interest rate, say 3% a year for example. When the Bank of Canada changes their rates, typically by a quarter percent at a time, the banks will typically change their prime rate by the same amount. I say typically because there was one instance in the recent past where when the BoC dropped rates by a quarter percent the banks only dropped there’s by .15%, effectively taking some of the discount for themselves and not passing along the savings to clients. 

·         The Bank of Canada reviews their rate once a month, meaning it can shift once each month (very uncommon for lots of back to back changes though)

·         Your rate can go either up or down depending on the market, meaning your payments will fluctuate over the term of your mortgage

·         Penalties on this are 3 months interest to break, but not all variables are created equal. Many lenders will charge you at the posted rate and not your contract rate, meaning higher penalties

·         Meant for people who have more financial flexibility in case of an event where rates go up

·         Can be predicted for short term, but long term it is difficult to say which direction a variable rate will go as there are too many factors that affect it

Which Should I choose?

There is a lot of discussion about what option may be right for you. One side of the coin is trying to predict the future. What will the next 2 years of rate market look like? What are current long-term projections? It’s a lot of educated guessing really at the end of the day.

We’re in a bit a curious situation right now in the markets. Since we have what is referred to as an inverted yield curve, and as a result, for the first time in a very long-time variable rates are higher than fixed rates. It is generally the norm for a variable rate to start lower than the fixed rate because you, as the borrower, are taking on more of the market risk from the lender. So, this created more appeal for gambling that the variable would remain lower and you end up paying less interest over the 5 years. Since as of writing this you could either get a 2.69% fixed rate, or a 2.95% variable rate for the same term the rate would have to drop twice before you’ve caught up to the fixed rate. It means there is much higher risk in the variable rate right now with very little reward vs a fixed rate. Here’s a chart of the BoC rate for the past 10 years:

I like this chart because it shows the neutral rates zone, where the central bank has expressed it would like to raise the variable rate to. The economy has not been cooperative over the past couple years, but you can see the trend. Because of this many people that were variable in the past have switched to fixed rate products. This chart ends in 2018, but the variable rate has been unchanged since then.

I believe with the economic pressure over the last 6 months and now the coronavirus fears, we will probably see a reduction in the variable rate sometime this spring. While fixed rates have also had downward pressure, until the variable rate truly becomes cheaper than fixed rates, I believe you’re better off taking a fixed rate product under general circumstances.

Remember not all mortgages are made equally and different scenarios call for different solutions. Therefore your mortgage professional should always go over your options with you to ensure you’re getting the right product that suits your needs.