I must confess, I didn’t know very much (well, still don’t really! There’s still much to learn) about fixed and variable mortgages, and what prime was etc. because I hadn’t ever encountered buying a place. I got really confused with open versus closed and thought open meant variable.
Now that I’ve been looking to get a pre-approved mortgage before the April 19 mortgage rules changes and have amassed somewhat of a downpayment, I’ve been asking around and meeting different mortgage brokers, spoke to mortgage specialists at banks, and sponged up all the information they could give me.
They all probably think I’m really annoying because I met with them, they spent their time with me, and then I didn’t follow through right away, but I wanted to make sure I am making the best decision I am able to make (hey, it’s the biggest financial decision of our LIVES, I think it’s okay to be indecisive and noncommittal, right?).
I wanted to share some of what I learned with you all, so that you can sound like you’ve been doing some research when you meet your mortgage broker or bank mortgage specialist. So here are some basics between variable and fixed and open and closed mortgages… that was a mouthful!
What is a variable or floating mortgage?
A variable rate mortgage (VRM), sometimes called a floating rate mortgage, is a mortgage where the interest rate fluctuates during your term. The variable rate is related to the Bank of Canada prime interest rate (which is 2.25% right now). That means, that if the Bank of Canada increases the Prime Interest rate, then your interest rate on your mortgage will go up too. The banks and mortgage lenders give a slightly better rate than the prime interest rate.
For example, you may see “Prime minus 0.15%” discount to price their variable rate mortgages and compete with different banks and mortgage lenders.
The Bank of Canada uses the prime rate to adjust for inflation. When there isn’t very much inflation, the prime rate will remain low. When inflation skyrockets, the prime rate will increase because the Bank of Canada needs to adjust for this.
Historically, choosing a variable rate mortgage saves you more money than choosing a fixed rate mortgage.
What is a Fixed Rate Mortgage?
A fixed rate mortgage, contrary to popular belief (including me!), is NOT linked to Bank of Canada’s prime interest rate. The fixed rate mortgages are set by the chartered banks in relation to the yield in the bond market. The bond market is highly unpredictable and is related to the political and economic conditions present. No one can predict what fixed rates will do, even in the short term, because of this volatility. That’s why they change all the time.
The rates change, but once you lock them in for that term, that’s the interest rate that you will get. Some people like fixed rates because they are guaranteed to be paying X amount over the term. Even though the payments are fixed, most lenders will allow you to pay a little extra more to chip away at your principle amount.
What is a Closed Mortgage?
A closed mortgage means that you are agreeing to a term. Terms can range from 6 months to 10 years. If you back out of the mortgage before the term is up, you will have to pay a penalty. Ellen Roseman, a columnist for the Toronto Star, reminds us that this penalty can be a shocker. The penalty is usually three months of interest, or the Interest Rate Differencial (IRD) depending on which one is HIGHER (but variable rate mortgages don’t have the IRD). Canadian Mortgage News has a great calculator you can use to see how much your lender can gauge charge you. It can be about $46,000 on a mortgage balance of 500,000 with 30 months remaining in the term and initial fixed interest rate of 5.70% vying for the current variable interest rates of 1.95%. Poof.
So if you are getting a 10 year mortgage with someone that you’re not sure is “the one” (which you shouldn’t do, anyways, but I suppose no one goes into these things thinking about break ups!), then just be extra cautious because not only will your heart break, your bank will break too.
Related: How To Port A Mortgage
Also, let’s say you won the lottery (a cool million, let’s day dream) and your house is worth a million. You can’t just pay off the loan just because you have the cash. You will have to pay a penalty to do this.
To refinance you will also have to pay a penalty. For example, if you were in a fixed mortgage rate and saw that the variable rate is so low and so you wanted to get in on some action. You could, but it will cost you!
So with all this downside to having a closed mortgage, you might think what’s the point, why not get a mortgage that doesn’t have any rules, circa 1969 man.
Well, because open mortgages charge you more in interest. There had to be a catch somewhere, right?
What are Open Mortgages?
An open mortgage, as mentioned above, is a mortgage with no rules. You can pay back the money you borrowed any time.
You could buy a house in January and sell it in March if you wanted, and not have to pay a penalty for breaking the term.
For variable open mortgages, for example, instead Prime MINUS 0.X%, it’s Prime PLUS 0.X%. The bank puts in all this effort in lending you money, so they need to try and make some money off you, because you could leave anytime you want.
Hope that little summary gives you a bit more grounding on making the BIGGEST FINANCIAL DECISION OF YOUR LIFE! In my books, knowledge is power =) Out of curiosity, to all you homeowner readers out there, did you pick open or closed and fixed or variable?
Below is a comparison chart from Ratehub who does all the heavy lifting when it comes to comparing mortgage rates across Canada.