As first-time homebuyers back in 2005, my husband and I had differing views on whether to go with a fixed or variable mortgage. He was “team variable,” armed with research showing that, on average, floating rate mortgages in Canada have outperformed five-year fixed rates. I was firmly in “camp fixed,” as I’m somewhat risk-averse and rates at the time were expected to rise. (Spoiler alert: they didn’t. They went down. By a lot.)
If you’re buying a house in Canada or your mortgage is coming up for renewal, you may now find yourself in a similar situation, weighing the pros and cons of a fixed vs variable rate mortgage and trying to predict which way rates will move in the future. So, how did we make our decision, and—more importantly—what can you do to figure out whether a fixed or variable mortgage is best for you?
I’ll get to what we decided later. First, here’s everything you need to know about fixed vs variable mortgages, the pros and cons of each, how to choose between the two, and tips for getting the best fixed or variable mortgage in Canada.
Fixed and Variable Rate Mortgages Explained
As the name implies, a fixed-rate mortgage is one where the interest rate on your loan is locked-in for the whole term. The most common term is five years, but there are shorter and longer terms as well. If, for example, you have a five-year fixed-rate mortgage at 2%, you will continue to pay that same 2% in annual interest for the entire five years—even if interest rates in Canada go up or down during that period.
When the term is up, you renegotiate the mortgage for another term based on the market rates at the time (and have another opportunity to choose between a variable or fixed mortgage). Rinse and repeat until you finish paying off your mortgage.
With a variable-rate mortgage (also sometimes called a “floating rate”), on the other hand, your interest rate will change whenever your lender adjusts its prime lending rate. While lenders can change prime rates at any time, they typically follow the central bank’s lead.
For example, when the Bank of Canada lowered its benchmark overnight rate by 1.5 percentage points in March, all of Canada’s big banks and most other lenders cut their prime rates by a corresponding amount. As a result, homeowners with variable-rate mortgages immediately saw their interest charges go down and experienced the benefits either through lower monthly payments, or a shortened amortization.
Pros and Cons of Fixed vs Variable Mortgages
There are advantages and disadvantages to each type of mortgage. Here’s an overview.
PROS CONS FIXED Payments are consistent so it’s easier to create a budget
You are protected from interest-rate increases during the term
Miss out on savings if interest rates decrease during the term
Significant penalty fees to break the mortgage midterm
VARIABLE Historically outperform fixed rates
More flexibility; can lock-in rate at any time
Immediately pay more when interest rates increase
Harder to budget when payments may fluctuate
How to Choose Between a Fixed or Variable Mortgage
There are four main factors to consider when deciding whether to go with a fixed or variable rate at any given time:
- Your risk tolerance. If an increase in your mortgage payments would send you over a financial cliff, variable rates—no matter how attractive—are probably not advisable. No one can predict the future, and your first priority is to make sure you can afford your payments to avoid defaulting on your mortgage and losing your home. On the other hand, if your budget has a fair amount of wiggle room, you can take on more risk with a variable rate if you think it will pay off compared to going fixed.
- Canada’s economic outlook. Governments raise interest rates when the economy is growing quickly in the hopes of tamping down inflation, and they lower rates when the economy is struggling to spur growth. That’s why interest rates in Canada are currently at historic lows—regulators are trying to offset the harsh impacts of the COVID-19 pandemic and economic shutdown. Some say with rates this low they can only go up—making a sub-2% five-year fixed rate (for those who qualify) pretty much a no-brainer. Still, experts are predicting an economic recovery will take at least three years if not longer, so rates are expected to stay low for the foreseeable future.
- The spread between the two rates. If there’s only a tenth of a percentage point difference between a variable and fixed rate, how much would the lower rate actually save you? On a $500,000 mortgage, you’d save about $25 per month, or $300 a year. (You can crunch the numbers for yourself using a mortgage payment calculator.) Is that worth the extra risk of choosing a variable rate, given that you could end up paying a lot more if prime rates start to climb?
- Penalties and fees. It can be very costly to break a fixed-rate mortgage, making them less attractive for those who expect to sell their home before the term is up.
If you simply aren’t good at making decisions, some lenders will let you split your mortgage into a 50% fixed rate and 50% variable rate.
Or you could do what my husband and I did. We compromised by going with a variable rate but setting our payments at the higher fixed rate as a kind of hedge. It turned out to be a winning move because, as previously noted, rates didn’t go up—they went down. And then went down even further when the 2008 recession hit. We kept our payment amounts unchanged throughout it all and paid off the mortgage 10 years ahead of schedule.
Of course, what worked for us then may not be the smart choice now, as it’s hard to imagine rates plummeting when they’re already close to zero.
Tips for Getting the Best Deal on a Fixed or Variable Mortgage
Regardless of the type of mortgage you choose, you want to get the lowest rate possible, as well as favourable prepayment rules to avoid extra fees if you want to pay down your principal ahead of schedule.
Start by using an online rate comparison site to compare fixed and variable rates at many types of financial institutions, including major banks, credit unions and online mortgage lenders. Note that these posted rates are not necessarily the ones you’d qualify for as it depends on your credit, location, and mortgage amount. If you have a longstanding relationship with a particular bank or another lender, it’s worth giving them a call to see if they might reward your patronage with a preferred rate.
You should also consider consulting a mortgage broker (a licensed professional who negotiates mortgages on behalf of clients), who may be able to land rates you wouldn’t be offered on your own. If you go with the rate they secure for you, the broker is paid a commission by the lender—there is no extra cost to you.
There are even online mortgage brokers, such as Breezeful, which allow you to conduct the entire process remotely. You’re matched with a dedicated online mortgage expert who provides unbiased advice and negotiates with lenders using a single credit report. If you accept their recommendation, they’ll even help you close the deal.
With a number of lenders currently offering five-year fixed interest rates at super low rates, it’s tough to argue the merits of going variable—unless you think you may need to sell in the near future and might get dinged for cancelling your contract.
Of course, if you aren’t able to qualify for these preferred rates and the spread between the fixed and variable rates you can get is significant, you may do better with a variable rate—especially since the consensus seems to be that the Bank of Canada won’t raise its benchmark any time soon. Plus, you can always choose to lock in your rate if or when that happens.