There is a lot to know about mortgages, but one of the most significant discussions you will encounter when shopping around is whether to choose a fixed or variable-rate mortgage.
Many people will tell you to choose a fixed-rate mortgage for the added security of knowing exactly how much you need to pay every month. Historically, fixed-rate mortgages are the go-to and makeup around 70% of all mortgage applications. However, with such a volatile market, it’s nearly a split, with the Canadian Mortgage and Housing Corporation (CMHC) confirming that 53% of home buyers up for renewal chose a variable rate mortgage over a fixed one in the final six months of 2021.
However, while the security is a definite bonus, there are also some downfalls of fixed-rate mortgages. Read on to learn more about how they work and whether or not they are the right choice for you.
What is a Fixed-Rate Mortgage?
A fixed-rate mortgage is a home loan whose interest stays the same throughout the loan term. This results in consistent monthly payments.
How Do Fixed Rate Mortgages Work?
So, what is a fixed mortgage rate, and how does it work? This mortgage type has a constant interest rate for the entire loan term duration. This means that no matter how much interest rates fluctuate during your term, your interest rates and your monthly payments will stay the same until the term is up.
The advantage of this is that if interest rates go up, your rates will stay the same and save you money on your mortgage payments. However, the same applies in reverse. If interest rates decrease, you will still be paying the higher interest you locked in for the duration of your term when you could have been spending less had you chosen a variable-rate mortgage.
Should You Choose a 5-Year Fixed Rate Mortgage?
Your mortgage term is when the mortgage contract you sign is in effect. Mortgage terms can vary from six months to 10 years, but Canada’s most popular mortgage term is five years.
Short-term mortgages are most popular with Canadians because they fall in the middle of the available options. The shorter the term, the more often you must renegotiate until you pay off your mortgage. Longer terms, however, are usually much higher rates because the bank or lender needs to try to account for interest changes over a decade. Given their popularity, the 5-year term has become the most competitive option with the best rates.
How Do Lenders Determine Fixed Mortgage Rates?
If you have read up on variable-rate mortgages, you will know that these rates are determined partly by the Bank of Canada’s overnight rate. However, when it comes to fixed rates, they are determined by the bond market. Banks and other lenders will use the bond yield as a baseline and then set higher rates for the fixed mortgage. It’s worth noting that this mortgage type does follow the bond yield trends. However, they are much quicker to increase rates rather than lower them.
Can You Negotiate Your Mortgage Terms?
Negotiating a mortgage is always an option, regardless of whether it is a fixed or variable rate. You’ll need to speak with multiple lenders to compare offers to have the best chance at negotiating. If this isn’t your cup of tea, hiring a mortgage broker is always beneficial.
Should You Choose a Fixed Rate or Variable Rate Mortgage?
As mentioned earlier, one of the biggest debates is whether to have a fixed vs variable mortgage, and you will find people who try to sway you either way. But, in the end, it comes down to what is best for your interests and financial situation.
The most significant advantage of a fixed-rate mortgage is consistency. You always know how much you will be paying. This can make it a lot easier for some individuals to budget and set aside money for payments, especially if you are someone who worries about money. In addition, having the stability of consistent payments can take away a lot of stress.
On the other hand, that doesn’t mean that variable interest rates are a terrible choice. Typically, the variable interest rates are lower when signing for a mortgage. This is because they come with more risk, so if you choose a fixed mortgage rate, you pay a premium in exchange for its stability. With variable rates, you don’t have that same stability. This could be beneficial if interest rates drop, then you end up paying less. But the opposite can as quickly be true, and you could end up paying higher interest rates.
Both have advantages and disadvantages; ultimately, it comes down to your comfort level and what you can afford to risk.
Pros and Cons of a Fixed-Rate Mortgage
Like any financial product, this type of mortgage has advantages and disadvantages. Here’s a quick rundown of the pros and cons to help you decide.
Pros
- With consistent payments, you always know what you are paying
- Allows you to ‘set it and forget it- don’t have to factor in possibly paying more
- Easier to compare loans between lenders
- It offers stability and eases anxiety
- Protects you from the volatility of rising interest rates through the duration of your term
Cons
- You end up paying a premium for that stability
- Historically, they end up being more expensive over time
- Stiffer penalties should you try to get out of a fixed-mortgage contract
Ultimately, the key advantages of a fixed-rate mortgage include predictable payments, protection from interest rate fluctuations, and long-term stability. This is likely your best bet for a mortgage if you value consistency and security.
Things to Consider Before You Choose a Fixed-Rate Mortgage
Fixed interest rates aren’t necessarily better or worse than variable interest rates. But, again, it comes down to the individual situation.
- What rates are lenders offering? Be bold and browse online, or hire a mortgage broker who can provide you with various options and help you score the best deal.
- What are you most comfortable with? These mortgages can be a fantastic fit if you like stability and consistency in your budget.
- What’s happening with the Canadian economy when you shop for a mortgage? Check out the Bank of Canada report each quarter, listen to real estate podcasts that monitor the market, and pay attention to what’s happening locally.
Before you make the decision, take the time to think it over and do some math. Several helpful mortgage calculators can guide this decision and provide insight into your payment and how to find the right lender.
Our Favourite Mortgage Calculators
Remember to shop around. Different lenders will have different rates on offer for both fixed and variable interest rates, and whatever you decide, you want to do your due diligence and ensure you get the best rate on offer.
