Variable vs Fixed / Open vs Closed Mortgages

Mortgage-YT-2

Buying a house and getting a mortgage can be a stressful experience – especially if you’re going through it for the first time.  Whether you’re going through a traditional bank or a mortgage broker, with terms such as variable, fixed, closed, open, prime interest rates and many more, it can be easy to get intimidated.  Because of all this new information zipping past you it’s unfortunately very common to misunderstand important details when it comes to what is often the most important purchase of our lives.

If you’re new to the process or just need a quick refresher on any aspect of the house purchasing process in Canada, check out our comprehensive FREE eBook: Getting Your Foot In The Door.

Quick Links

Since I’ve been looking to get a pre-approved mortgage for a while now after amassing a down payment (check out the free ebook if you want to know more about how I saved for a down payment) I’ve been researching and meeting with a variety of mortgage brokers and bank specialists.  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 with your mortgage people.  Here are some basics when it comes to variable vs fixed and open vs closed mortgages.

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 that you are paying can go up or down during your mortgage term.  The variable rate is related to the prime interest rate.  The term “prime interest rate” refers to the interest rate that a bank extends to their most trusted customers.  This preferential rate is based on the Bank of Canada’s overnight rate or key interest rate – which is the rate at which banks get money from the Bank of Canada.  All of this means that if you choose a variable mortgage, your payment will go up or down depending on what the Bank of Canada does and how your bank (or other lender) reacts with their prime interest rate.  While some people think they know what the BoC is going to do when it comes to interest rates, the truth is that no one knows what interest rates will do over the long term.

You will often see banks advertise their variable interest rates as “prime minus .2%” or something similar, which means that you will get .2% off of the floating prime interest rate – which could go up or down (or stay the same – the most common occurrence lately) throughout the length of your mortgage term.

Best Mortgage Rates Canada

Historically, choosing a series of variable rate mortgage terms over the course of your overall mortgage will save you more money versus choosing fixed rate terms each time your mortgage comes up for renewal.  Yet Canadians still tend to drift towards fixed interest rates because of the predictability and safety factors.

Mortgage-YT-3

What is a Fixed Rate Mortgage?

Fixed rate mortgages are a little easier to understand and have remained a favourite amongst Canadians for years.  The basic idea is that you sign on for your mortgage term of X years at a specific rate, and during that time the bank can’t change your interest rate regardless of what the Bank of Canada or the prime interest rate does.

Your True Best Mortgage Rate

In return for this simplicity and security, banks and other lenders will demand a premium.  Consequently, expect to pay a little bit higher interest rate if you choose this option (banks have to protect themselves against possible interest rate rises after all).  This is ultimately why sticking with a variable rate has proven to almost always be cheaper over the long term, even though they do entail some risk of rising interest rates in the short term.

There is a third option when it comes to mortgage interest rates called a hybrid mortgage.  This is essentially when a mortgage agreement has a certain portion of the amount borrowed as a fixed rate, and the rest as a variable rate.  This option is rarely chosen by Canadians, but can offer an interesting middle-ground when it comes to risk and reward.

What is a Closed Mortgage?

When it comes to your mortgage, the terms closed vs mixed essentially refer to the ability to pay off all of the remaining money that you owe on a mortgage loan and be done with the loan instantly at any point in time.  Most Canadians prefer the simplicity of a basic closed mortgage with fixed interest payments. They are easy to understand and there are no surprises; however, closed mortgages cannot be fully paid before the end of their term. Most lenders allow limited pre-payment privileges (i.e., extra payments over and above your normal mortgage payment). These privileges allow you to pay a certain percentage of the original mortgage amount with no penalty, but full payoff requires that you pay a penalty – unless you wait for your maturity date.

Related: How To Port A Mortgage

The vast majority of Canadians don’t have the means to pay their mortgage off all at once or at an extremely accelerated rate; therefore, most aren’t worried about the fact that they are “locked in” for the length of their term. In exchange for sacrificing some flexibility with a closed mortgage, lenders will usually reward you with a significantly lower interest rate compared to an open mortgage. Typically, the majority of rates you see displayed on rate comparison sites or bank advertisements are for closed mortgages.

Mortgage-2-YT-1

What is an Open Mortgage?

An open mortgage is appropriate for people who want flexibility built into their mortgage. You can typically pay off an open mortgage at any time without penalty or convert it to a closed mortgage. Some people like this flexibility if they expect to sell their home relatively soon, or come into a large sum of money, which they can use to pay off their entire mortgage.

For more information on fixed vs variable rates, closed vs open rates, and other mortgage stuff like down payments, mortgage contract details, the Home Buyer’s Plan, and much more, download our FREE eBook: Getting Your Foot In The Door: The Ultimate Guide to Buying a Home in Canada.

24 Comments

  1. Financial Cents on April 12, 2010 at 10:24 am

    @Young & Thrifty – We picked a closed mortgage (unfortunately) a few years back. We did so because my wife wanted the security against rising interest rates, although I was more than willing to watch the rates… Oh well. “They” (the experts (economists)) said interest rates were going to rise. That was in 2007. Here we are, spring 2010, just on the cusp of that reality. We’ve paid more than we should have in mortgage interest, but we’ve been able to actively budget around that fixed payment as well, making lump-sum mortgage payments on top of our regular payment, so all is not lost 🙂 Nice post!



  2. young on April 12, 2010 at 10:47 am

    @Financial Cents- That’s good that you’ve been able to make lump sum mortgage payments- it helps chop away at that beast. Thanks for sharing your mortgage choice! =)



  3. Larimerboy on April 12, 2010 at 3:02 pm

    Good stuff for all the young and thrifty out there.

    When I bought my place I was one of those sub-prime mortgage people! 5% down, Interest only mortgage 10yr-ARM (YIKES!)…. I learned my lesson and was lucky enough to refinance and get a fixed-rate 30 year at a touch over 5%. There is something very nice about knowing what my payment will be each month for as long as I own the house. I make additional payments to payoff the principle but am thrilled to be out of the Variable Rate Business.



  4. Investing Newbie on April 12, 2010 at 8:43 pm

    This is a great post. I want to get into Real Estate but I don



  5. young on April 12, 2010 at 8:35 pm

    @Investing Newbie Great! I have a post scheduled for Wednesday that talks about Variable vs Fixed =) The Open Fixed Rate doesn’t have that long of a term (usually 6 months to 1 year) and the interest is MUCH higher than a closed fixed rate. For example, at CIBC (a bank from Canada) the open fixed rate is currently 6.45-6.70%. With a 5 year fixed rate, you could get something as low as 3.80%. I guess it’s okay if you plan to flip the house and you think that the real estate market is going to pop within short term. =) (pop as in go higher, not housing bubble burst!)

    @Larimerboy Wow, how did you sleep at night? =) It’s kind of funny (or rather, scary) how people can just approve you just *like that* (I was snapping my fingers) without really checking if you can truly afford something- it’s like you almost need to tell yourself what you feel comfortable with, otherwise, the bank will just max you out. Glad that you’re feeling more comfortable now- it’s nice to know what you have to pay each payment. =)



  6. Tom @ Canadian Finance Blog on April 14, 2010 at 9:37 am

    Thanks for the mention!



  7. chantl01 on April 14, 2010 at 12:31 pm

    Thanks to the advice of a wise friend who also happens to be a mortgage broker, I lucked in to an open variable mortgage at Prime -0.7% in the summer of 2008. Immediately after which the prime rate started plummeting, yay for me! I’m sticking with the variable rate and paying more than if I had a fixed 5 year rate, plus throwing the odd lump sum at it. I’ve already reduce the amortization from 20 to 8 years and figure I’ll get it close to paid off before the rates ever get close to what they were as fixed rates when I signed.



  8. Guy G. on April 14, 2010 at 6:30 pm

    Hey,
    I haven’t been in on the variable vs Fixed debate in a while. We’ve been focusing on helping our clients and readers with tips on budgeting to reduce costs. I guess saving on mortgages does tie in a fair bit.

    Just wondering if you heard that the Royal Bank raised it’s rates today. Don’t you think the others will follow suit and that this is one of many rate increases?



  9. young on April 14, 2010 at 7:57 pm

    @Guy G. Yup! Heard that RBC raised their rates. Yup, I think that others will probably follow suit… I hear that at the credit unions, you can still get some good rates, like 3.69% for a 5 year fixed. I guess it’d be helpful to a) negotiate like mad or b) try and find a mortgage broker…

    @chantl01 PRIME -0.7% that’s awesome!! Wow you were probably paying like.. 1.5% interest- crazy! That’s the strategy that I plan to use. That’s amazing that you reduced the amortization from 20 to 8!! You’ll be debt free in 8 years! Congrats!



  10. Simple in France on April 17, 2010 at 11:02 am

    I really don’t find fixed interest rates to be a rip off. Regardless of what interest rates do in Canada or elsewhere, I see interest as a way for banks to not lose money through inflation when they lend to you–inflation in my opinion is bound to beat interest rates in the next 10 years. The housing market can’t crash that much more. . .can it?

    I would want to have a fix interest rate on any mortgage I took out because I would want to be absolutely sure how much I was going to pay–and that I can afford it. But . . .I really don’t like risk. It’s not always my investing strong point–however, in the past couple of years, that has served me well.



  11. young on April 18, 2010 at 7:24 am

    Thanks for visiting, simple life. Yeah part of me isn’t good with risk either and part of me wanted to go fixed.. I think if it were my own mortgage instead of one with my boyfirend I might go fixed 🙂



  12. Fixed Rate Bonds on November 6, 2011 at 11:37 am

    I think it is useful to hear about fixed and variable rate mortgages from yourself as you explain things in simple terms, without all of the unnecessary marketing garb that so many companies use. I really like the fixed rate nature of most investments, be it mortgages or bonds as i can easily budget then but what is actually best in the long term i believe is impossible to be sure.



  13. Pam on October 21, 2012 at 7:44 pm

    Thanks for explaining what all the different types of loans are as I recently talked with a lender and was totally lost. I am leaning towards getting a fixed rate mortgage right now but I just don’t know if I will qualify and still get a decent rate.

    Pam



  14. Should I Buy Mortgage Life Insurance? on September 19, 2013 at 12:24 pm

    […] Variable and Fixed, Open and Closed Mortgages […]



  15. Dany Sewell on January 28, 2014 at 11:55 pm

    With a fixed rate mortgage, the mortgage rate and payment you make each month will stay constant for the term of your mortgage. With a variable rate mortgage, however, the mortgage rate will change with the prime lending rate as set by your lender.
    Fixed mortgage rates eases budgeting anxiety and offers stability. But then if the difference between the variable and fixed rate is significant, it may not be worth paying a premium for the stability protection of a fixed rate. On the other hand variable rates have proven to be less expensive over time.
    Open mortgages allow you to prepay any amount of your mortgage at any time without a compensation charge. You can also make additional payments without penalties. Open Mortgage terms range from 6 months to 5 years and can have variable or fixed interest rates. Closed mortgages have a prepayment limit, which means you are only permitted to pay 15% of the original principal balance of the mortgage per calendar year. If you elect to pay more than 15% within a single calendar year, compensation charges will apply. To reduce the penalties you can discuss with your mortgage brokers. This type of mortgage is more stable due to its restrictive nature, which is why interest rates are lower than they are for open mortgages.



  16. […] Variable and Fixed, Open and Closed Mortgages […]



  17. Red on April 26, 2016 at 3:10 pm

    Super helpful; both original, comments and reply alike, however, I see not one date anywhere and therefore am simply wondering how up to date these rates are. As per my recent rate reviews, they look recent but could you please advise? Much appreciated still since my current mortgage, which is due to be renewed, is with RBC and my main bank is with a Credit Union. We’lol see where this goes…



  18. Kyle on April 27, 2016 at 10:02 pm

    They are within the last couple years and pretty up to date Red. My bet is on your Credit Union? Have you checked out our free ebook on housing? It has some great advice on how to negotiate rates and where to find the best ones: youngandthrifty.ca/buyin…in-canada/



  19. Claudia on August 9, 2016 at 7:58 am

    Hello, I own a house but bought a condo that will be ready in about 18 months from now, the catch is, I need to renew my mortgage now (I have to live somewhere for 18 months :)), the bank where I have my current mortgage is offering me 2.35% on a closed variable 5 year term mortgage, they say that even if I break the mortgage within 12-18 months, the only penalty will be 3 months, is this correct?, I would very much appreciate any insight on this, thank you!!,
    Claudia



  20. Leonie on February 5, 2017 at 10:46 am

    Hi, The Fixed rate is different to the variable because it is based on long term bond rates. It is not based on the overnight lending rate or related to the variable ate in any way. Definitely not a premium charged on variable by the bank.



  21. Leonie on February 5, 2017 at 10:58 am

    Athough the Variable rate is loosely based on the BoC rates, the bank do move their Prime rates independently. That is how they do not pass on full BoC rate drops. I got caught in the Dec 2016 TD .15%rate rise, for no reason. Mortgage rule change used as excuse, but other banks did not follow suit. This only affected customers stuck in their 5 year term. TD will advertise a greater discount under their prime to new customers to remain competitive with other banks. The mortgage rule change did not apply to established mortgages. Pure money grab. Variable rate is actually “let the bank charge whatever they like” rate, until it is cheaper to refinance. It is really based on your banks integrity, and what they can get away with. Agree that Variable is cheaper in the long term, but bank intergrity is factor as well as rate when choosing lender.



  22. Kyle on February 6, 2017 at 1:44 pm

    Hi Leonie – while it’s true that rates do move independently, if you have a perfectly competitive market they should move in tandem with the BoC rate. Unfortunately you just highlighted the fact Canada’s system can be a less than competitive market at times (to say the least). I think most businesses will get away with what they can when it comes to profit margin. Usually the market will balance out quickly because obviously as a dissatisfied customer you will not go back right? This is also another argument for 1-year variable agreements!



  23. Kyle on February 6, 2017 at 1:47 pm

    This is both true and not true Leonie. The fixed rate depends on several things. Yes, the long-term bond rate does affect it, but that’s because the bond rate is indicative of what a bank will be paying out and taking in, in terms of cashflow – and consequently the profit margin! There is most definitely a premium attached to taking a fixed rate vs a variable rate. Also, long-term bond rates are heavily dependent on the BoC’s rate amongst other things, so to say they are not related to the variable rate is not quite true. It’s more the like one does not cause the other, but because similar factors affect both there is a high correlation.



  24. John McKay on February 6, 2017 at 2:40 pm

    Great article for those shopping for a mortgage. Maybe it takes a bit of the stress out of the whole deal. I did things wrong the first time around, I just went to the bank and did what old Pops said ….. I ended up with a lousy rate for 5 years. Eventually I changed, I renewed with a variable ……… and renewed again. It is true that history proves that variable rate mortgages outperform fixed rate. I’ve seen my rates adjusted up and over, (pain) and then eventually back to even. Variables are great when they are low and they are stressful when they go up. I checked in with a few brokers, didn’t like them at all. I chose an agent and did a DIY mortgage, best choice by far. What I found is that everyone is unique, just because you have a mortgage doesn’t mean that you’ll get the lowest rates. In my case, I wanted the best rate and numerous firms told me that if you want that rate you must have a minimum mortgage of over 250K. Some of the firms wanted a minimum time frame for the maturity as well. There were quite a few differences. The best choice for me was a DIY mortgage (an agent) rather than a broker or bank. I put my information out there and had about 20 or more seriously competitive offers, I shortlisted and chose the best one for me and my situation. I locked in for 5 because the rate was so low I felt good about it. (I’ve got to tell you though, I damn near went variable but instead made the low stress choice, my stomach is happier). It’s hard to predict the future and I can say that in my opinion it is a must to have the mortgage open, don’t let others control you ! I have made a few lump sum payments here and there, I’ve added a little extra here and there . Over time this is well worth it. When in doubt, consider a short term, just don’t give in to the bank like I did when I was young & stupid. Banks are the worst place to get a mortgage.



  25. Mo on September 14, 2017 at 6:07 pm

    I worked for CIBC in the 80s. Mtge rates topped out at 21.46 per cent! This was a nightmare time for some homeowners. When rates are low and you want to sleep at night, go fixed for as long a term as you can get!



Leave a Comment





53 Shares
Pin13
Tweet10
Share22
Share7
Email
+11