Fixed Rate Vs Variable Rate Mortgage
Updated: Jan 18, 2022
If you are looking for a short answer on Fixed vs Variable the short answer is Variable. However, if you want to understand why, just keep reading.
In simple terms, a fixed-rate mortgage is a mortgage where the payment and interest rate will stay constant for the entire mortgage term, generally 5 years. The disadvantage with this type of mortgage is that if for any unforeseen reason you have to sell or refinance your property and break the mortgage, there are penalties associated with early termination that can be very costly. Statistics show that the average penalty for breaking a fixed-rate mortgage is around $27,000.
However, if you do not foresee any possible reason why you would want to break your mortgage early, and you are in an environment where the interest rates are going up, only then, it may make sense to lock in the low rate now.
On the other hand, in a variable-rate mortgage, the interest rate may vary up or down during your term, following the prime rate dictated by the Bank of Canada. What will stay constant with a variable rate mortgage is the interest rate premium or the discount from the prime rate received at origination.
The penalties on a variable rate are always 3 months of interest or around 1.5x your payments. If your payment is $2000/month your penalty will be around $3000. So, it becomes really evident that if you opt to refinance, the savings on the penalty alone are worth it.
For the traditional home buyer, as of March 2021, the difference between a variable rate and a fixed rate is small (5 years fixed 1.80% vs 1.40% 5 years variable) which translates to a difference of $18.94 per month per $100,000 borrowed making it tempting get the fixed rate. However, the younger you are or the less predictable your life is, the more likely you are to have a major life-changing event like changing jobs, moving to a different city, having a baby and needing more space, getting married, getting divorced, and so on. Unfortunately, generally speaking, those events will not coincide with your mortgage term. So, selling your property or having to refinance will trigger the penalties.
An important statistic to mention, is that 60% of the mortgages are broken before the end of their term at an average of 38 months from origination. So, to avoid the high penalties it is better to get the variable interest rate mortgage. For context, if you are scared of your payments going up, a doubling of the interest rate, increases your mortgage payment by only 20%. So going from 1.5% to 3% will make your payment go from $399.94/month/$100K to $474.21/month/$100K. And there are variable rate mortgages that will keep your payment constant.
In conclusion, if 2020 taught us something, it was that life is unpredictable and that your economic situation can change rapidly. So if your life is variable, so should your mortgage be. And as situations vary from person to person, the best way to know which mortgage is best suited for you, is to talk with a Mortgage Professional at RefinanceBC. Call us today for personalized mortgage advice.