Fixed vs. variable-rate mortgages

Key takeaways

There are 2 main types of mortgages, fixed rate and variable rate.
With a fixed-rate mortgage, your interest rate and payment stay the same over the mortgage term.
With a variable-rate mortgage, the interest rate can move up or down according to the lender’s prime interest rate.

How does a fixed-rate mortgage work?

With a fixed-rate mortgage, the interest rate and your mortgage payment will remain the same throughout your mortgage term.

How does a variable-rate mortgage work?

With a variable-rate mortgage, your mortgage payment will stay the same throughout your mortgage term, but the interest rate can go up and down along with the prime interest rate.

Comparing fixed-rate and variable-rate mortgages

Fixed-rate mortgage

Benefits:
- Because interest stays the same, you’ll always know when you’ll pay-off your mortgage.
- Easier to understand than a variable-rate mortgage.
- You’ll have confidence knowing what to budget for mortgage payments.
Concerns:
- The initial interest rate is often higher than a variable-rate mortgage.
- You’re locked into your interest rate for your entire mortgage term.
- If you break your mortgage for any reason, penalties will likely be greater than a variable-rate mortgage.

Variable-rate mortgage

Benefits:
- The initial interest rate is often lower than a fixed-rate mortgage.
- An initial lower payment may help you qualify for a larger loan.
- If the prime rate falls and your interest rate falls accordingly, more of your payments will go towards the principal.
- You can convert to a fixed-rate mortgage at any time.
Concerns:
- If the prime rate rises and your interest rate goes up accordingly, less of your payments will go towards the principal which could make the amortization period longer.

Is a variable-rate mortgage better than a fixed-rate mortgage?

If the financial uncertainty of a variable-rate mortgage doesn’t scare you, in a low-interest rate environment, a variable-rate mortgage could be a better choice because the rate is likely to be lower than a fixed-rate mortgage, which can save you a lot of money.

However, if you like knowing your mortgage payment will stay the same, regardless of if mortgage rates rise or fall, then a fixed-rate mortgage is your best choice.

Can you switch from a variable-rate to a fixed-rate mortgage?

You can change your mortgage rate type at the end of your term when you renew your mortgage.

Some lenders also allow you to convert your variable rate to a fixed rate during your initial term.

Can you negotiate your mortgage interest rate?

The short answer is yes, but not always.

You may be able to negotiate on the interest rate a bit. It pays to compare rates from various lenders. If you find a lower rate elsewhere, by all means ask your lender if they can match it or do even better.

Often, you’ll have the most luck negotiating if you have an attractive mortgage application. That includes a good down payment and credit history, stable income and low debt service ratio. If you already have other products with the lender (i.e. investments, insurance or even a credit card) you may also get a better rate.

Prepayments and penalties

A prepayment is how much you pay down on your mortgage on top of regular payments, without having to pay a penalty. It will vary depending on the mortgage lender.

A prepayment penalty is a fee that your mortgage lender may charge if you:

Pay more than the allowed additional amount toward your mortgage
Break your mortgage contract
Transfer your mortgage to another lender before the end of your term
Pay back your entire mortgage before the end of your term, including when you sell your home

You’ll likely pay the largest penalty with a fixed-rate mortgage. It’s usually based on the interest rate differential (IRD) which is the difference between your original locked-in rate and the interest rate your lender is currently charging. Ask your lender for a clear breakdown of IRD costs.

With a variable-rate mortgage, the prepayment penalty will likely be much less, often about 3 months of interest payments. However, once again, contact your lender for an exact penalty calculation.

Variations of fixed and variable-rate mortgages

Open fixed-rate mortgage

Allows you to prepay in full or in part and change to another mortgage term at any time, with no penalty. It’s similar to an open variable-rate mortgage, except the interest rate will be locked in for the entire mortgage term.

Closed fixed-rate mortgage

Your interest rate and payments will stay the same according to your chosen term. With this type, the interest rate is often lower than open rate options, so it may work better if you have a strict budget. Also, it can’t be fully paid off, refinanced or re-negotiated before the end of the term without incurring a penalty.

Open variable-rate mortgage

You can make as many prepayments as you want, pay off the entire balance, or switch to another term at any time—all without penalty

Closed variable-rate mortgage

Your payments will usually stay the same for the entire mortgage term with limited prepayment options. With this type, ask your lender whether you can make lump-sum payments, how much and when.

Adjustable rate adjustable payment mortgage

Your interest rate and payment automatically adjust every month as interest rates rise or fall.

Lock and roll mortgage

Your interest rate and payment automatically adjust every 6 months.

How the prime rate affects variable mortgage rates

Canada’s prime rate is the interest rate that most Canadian major banks charge their best customers. The prime rate varies with performance of the Canadian economy and inflation forecasts.

With a variable-rate mortgage, the interest rate you pay is tied directly to the prime rate and will move up and down with the prime rate.

If the prime rate falls, more of your payment goes towards to the principal. This means, you pay off your mortgage faster.

However, if the prime rate rises, more of your payment goes towards the interest, and less to the principal, meaning it could take you longer to pay for your home. If the prime rate increases to a specific percentage or trigger point (listed in your mortgage contract), your lender may increase your payments to ensure you pay off your mortgage by the end of the amortization period.

If you have a tight budget, an increase in your mortgage payment may impact your ability to make your mortgage payment or take care of other household expenses.

What’s an interest rate cap?

To protect yourself if interest rates rise, you may want to ask your lender about an interest rate cap. This is the maximum interest rate your lender can charge on your mortgage. Even if interest rates increase, you won’t have to pay more than the maximum cap.

Historical comparison of fixed-rate and variable-rate mortgages

Variable-rate mortgages have been historically proven to be less expensive. That said, According to Mortgage Professionals Canada | PDF 2.3 mb, about 77% of all mortgages are fixed rate, while the remainder are variable rate (18%), or a combination of fixed and variable rate (5%).

What's next?

Now that you understand more about fixed-rate and variable-rate mortgages, you may want to contact your advisor to:

Discuss what type of mortgage best meets your needs.
Ask about competitive mortgage interest rates.

This material is for information purposes only and shouldn’t be construed as providing legal or tax advice. Every effort has been made to ensure its accuracy, but errors and omissions are possible. All comments related to taxation are general in nature and are based on current Canadian tax legislation and interpretations for Canadian residents, which are subject to change. For individual circumstances, consult with your tax, legal or accounting professionals. This information is provided by The Canada Life Assurance Company and is current as of date of publication.