FIXED VS VARIABLE RATE MORTGAGES IN CANADA

Whether you are a first-time homebuyer or refinancing your home, you may be stuck between difficult situations deciding which term of payment to choose. Most Canadian mortgage lenders discuss their terms based on two types of payments; Fixed and Variable rate mortgages. While some marketers offer numerous varieties within these two terms, your first step is to determine which category suits your budget. Therefore, before going for any of the two terms of payment, you should know all the necessary facts behind each option for you to negotiate with the lender. This article briefly outlines the merits and demerits of each mortgage in Canada for you to make a wise choice.

What Is A Fixed Rate Mortgage?

With a fixed-rate mortgage (FRM), the monthly payment does not change throughout the loan. Each payment made goes directly towards paying off the principal loan and the accrued interest. However, although the monthly payment remains the same for the whole period, the percentage of each payment that goes towards clearing the principal loan and the interest varies with each payment as you clear the mortgage. In short, the two are indirectly proportional to each other where the interest slowly decreases as the principal paid increases.

How Fixed-Rate Mortgages Are Determined in Canada

The Canadian fixed mortgage rates are determined depending on the prime rate and the economic conditions at the time you enter into the contract. This means your term will remain the same the entire period regardless of the economic changes and the fluctuations in the prime rate. In Canada, bankers, and lenders calculate their mortgage rates based on the Bank of Canada benchmark rate, which is a rate that all banks and lenders must adhere to when approving borrowers for mortgages. This is because the government wants to ensure that every Canadian can handle any market volatility. Mostly, the benchmark rate is about 1.5% higher than the best rates in the market.

Advantages of Fixed Rate Mortgage

A fixed-rate mortgage can be attractive to home buyers.  However, why should you choose a fixed-rate mortgage and why not? Here are some of the pros of FRM in Canada;

• You already know how much your mortgage will cost for the set period; hence creates security and peace of mind. This can be a great idea for first-time homebuyers.

Disadvantages of Fixed-Rate Mortgages

It is also vital to familiarize yourself with the following drawbacks of a fixed-rate mortgage before settling for it and compare with its advantages;

• Lack of Flexibility: When taking a fixed mortgage rate, you should be certain that you are going to adhere to the terms regardless of the economic fluctuations. However, you can transfer the mortgage although it comes with additional costs since you will still be forced to re-apply for the mortgage again.
• Possible Losses When the Interest Rate Falls: Taking a fixed-rate mortgage means you will continue paying the same rate even when the market interest rate falls. Therefore, you will pay more than what you should for months or years.
• Penalty to break : In most cases the penalty to break a fixed mortgage will be greater than three months interest compared to a ARM. It is calculated in most cases, the greater of three months interest payments or IRD (interest rate differential)

What Is A Variable Rate Mortgage?

A variable rate mortgage or an Adjustable-Rate Mortgage (ARM) is a mortgage term in which the interest rate paid on the outstanding loan changes with time basing on the benchmark rate. At first, there is a fixed interest rate for a specific time which is adjusted depending on the changes in the market rate. Therefore, as the interest rate changes, the monthly payment varies. Although the monthly payment for a variable-rate mortgage may be lower than the fixed-rate mortgage, the payment can go higher than what you would expect if the interest rates rise.

How Variable-Rate Mortgage Is Determined in Canada

The Canadian variable rate mortgage is determined by the prime rate and changes every time the prime rate fluctuates. The prime rate is the average interest rate used by major banks and lenders to set their rates. It is usually determined by the overnight rate set by the Bank of Canada and is influenced by the cost of borrowing for the major Canadian financial institutions. In most cases, the variable mortgage rate is indicated as 3.95% with a prime rate of 1.20% underneath it. This means the prime rate will be 5.15% with a discount of 1.20% bringing it to an interest rate of 3.95%.

Advantages of Variable Rate Mortgages

Here are some of the advantages of ARM over fixed-rate mortgage;

• Lower initial payment makes more home buyers qualify for the mortgage.
• Unlike a fixed rate mortgage, the variable rate mortgage can be converted to a fixed rate mortgage at any time, fixed cannot be converted to. Variable rate mortgage.
• The penalty to break a variable rate mortgage is usually only three months of interest payments at any time during the term of the mortgage.

Disadvantages of Variable Rate Mortgage

The main disadvantage of an ARM is that you do not know how much the mortgage will cost you. After the introductory interest rate, the payments fluctuate and increase or decrease depending on the changes in the prime rate. Another challenging factor about the ARM is the vocabulary used on the terms of the loan. Therefore, as a new home buyer, you must familiarize yourself with vocabulary like adjustment frequency, adjustment index, margin, cap, and ceiling.

Bottom Line

It is crucial to note that all mortgage rates have their pros and cons that you must consider before settling for one. Whether you are going for a fixed rate or variable rate mortgage, you should choose wisely depending on other factors like your household income, plans with the property, and your comfortability with the selected type. However, new home buyers are recommended to take the advantage of a lower variable rate which can be converted into a fixed rate later depending on the terms mortgage.