Updated Article: July 8 2024
If you’re in the home buying process, you are probably wondering the difference between fixed vs variable rate mortgages. These are the two types of mortgages you can go with – a fixed mortgage or a variable rate mortgage.
In this blog post, I explain both options and when you would pick one or the other.
In 2017 the Federal Government introduced a stress test for anyone applying for or renewing a home loan. This is usually 2% or higher than the rate you will receive for your mortgage and targets to make sure you could handle a future higher rate. All qualifying is based on this and will effectively lower the amount you qualify for to account for future higher rates.
Many people reach out to me not fully understanding the stress test and what it means for their unique situation. If you’re in that boat, you can give me a call or send me an email and I’d be happy to answer any stress test questions you have!
A fixed-rate mortgage means that the interest rate of the mortgage will stay the same until the mortgage is up for renewal. This is when you’ll hear the term “Five year fixed”, but terms can be shorter or longer than five years.
The current rates are decided by the Government of Canada’s bond yields at the time of purchase and won’t change even if those bond yields do throughout time.
A fixed mortgage rate is a great option for people who don’t like surprises. You will know every single month what part of your mortgage payment is going towards interest and which part is going towards your principal. You will also be able to account for mortgage payments for the number of years that your mortgage is. This will allow you to budget and put extra payments towards the mortgage loan if you have more money coming in.
Say you have an income of $80,000 with no debt and have 5% down payment saved. You could potentially qualify for a $320,000 home using the current rate of 4.79%, with a stress test rate of 6.79%. Note that I used a strata fee of $350 monthly and property taxes of $2000.
Each of these could be slightly higher or lower depending on the property tax amount and square footage as each lender has a calculation where they may use a lower property tax amount and a certain price per square foot for heating.
In this example, your mortgage rate would be 4.79% for your fixed term. When we work together, I will give you my personal suggestion on whether a fixed rate like this or a variable rate is better. If we decide on a fixed rate mortgage, we will decide together on what term will work best for your situation – whether it’s 3 year, 4 year, 5 year or longer fixed.
A variable-rate mortgage is when the interest rate of the mortgage will fluctuate throughout the term. These rates are decided by the Bank of Canada’s lenders’ prime rates. The Bank of Canada adjusts the Prime rate depending on the state of the economy.
Keep in mind that the rate is based off of a discount, so if the Prime rate of Canada goes up, then so will your variable rate.
One benefit of the variable rate is that if you break your mortgage term by selling or refinancing, you will only pay a penalty of three months of interest. This is approximately half of your mortgage payment multiplied by three.
The second main reason you would go variable is if prime isn’t projected to increase in the next year or two. If it’s projected to stay the same, and it’s a big difference from the fixed rate, it’s a risk vs reward situation. It can be quite the reward, but it can also be quite the risk. For example, over the past several years while interest rates spiked, variable mortgage rates also spiked. This affected a lot of people’s ability to afford their mortgage payments.
But, at the same time, I’ve seen people succeed greatly with a variable rate mortgage and be thankful that they went that route.
To understand a variable rate, here is an example.
3 years ago a common variable rate mortgage was Prime (2.45%) minus 1%, for a rate of 1.45%. In March 2022 to mid 2023 Prime then rose to 7.2%, so that same rate calculation would then be 6.2%!!. Currently, when it comes to variable rates, a common rate is Prime (6.95%) minus 0.95%, which is 6% compared to a fixed rate of 4.79%.
Deciding on whether to go fixed or variable in your mortgage is a big decision. When you work with me, a Kelowna mortgage broker, I will guide you through your decision. I can explain both options, let you know the current rates and offer guidance in deciding which route to go with.
If you’re currently in the house buying process or want more information on rates, reach out to me today. Give me a call at 250-826-3111, contact me through the form below or fill out a pre-approval on my website now. I look forward to helping you in your mortgage journey.
Originally posted: September 2, 2021
Let’s get your application off the ground.
