Fixed, Variable or Adjustable?

Deciding between fixed, variable, or adjustable rate types depends on factors such as payment stability, minimizing interest costs, and comfort with payment fluctuations. While fixed rates are directly influenced by Government of Canada bond yields, variable and adjustable rates are directly influenced by the Bank of Canada policy interest rate.

*As of April 16th, the Canadian Prime rate stands at 4.95% (across most Canadian financial institutions).

Key Insights: 

Fixed-Rate Mortgage:
The interest rate remains fixed for the entire term, ensuring consistent payments.

Pros:

• Ideal for stability and protection against market fluctuations.
• Can be cost-effective if secured during a period of low-interest rates.
• Allows you to budget and plan more effectively, as the payment will not change during the term.

Cons:

• Penalties for breaking a fixed-rate mortgage may be higher.
• If market interest rates decrease during the term, borrowers won’t benefit from lower rates without refinancing.
• If market rates remain stable or decrease after obtaining a fixed-rate mortgage, borrowers may pay more in interest over time compared to variable/adjustable-rate options.

Good to know:

• The 5-year fixed product is the most popular term in Canada.
• Suitable for those planning to own their home for an extended period.
• May involve higher costs if refinancing is pursued before maturity to take advantage of a lower rate.

Variable Rate Mortgages (VRMs) & Adjustable Rate Mortgages (ARMs):

Variable rate and adjustable rate mortgages offer flexibility and potential savings compared to fixed-rate mortgages. The key difference lies in how payments are managed: VRMs keep payments stable while interest allocation changes, whereas ARMs adjust payments directly in line with interest rate movements.

Both options often allow you to switch from a variable or adjustable rate to a fixed rate, subject to the lender’s fixed rates at the time of conversion. This can be advantageous if market sentiment suggests that rates are decreasing, as borrowers may secure a variable rate initially and switch to a fixed rate once rate decreases seem to have reached their lowest point.

Variable-Rate Mortgage (VRM):
Your interest rate adjusts in response to changes in the lender’s prime rate. Despite fluctuations in interest rates, your mortgage payment typically remains constant.

Pros:

• Fixed payments mean that when rates decrease, a larger portion of your payment goes toward the principal.
• Initial rates are often lower than fixed-rate mortgages, resulting in lower monthly payments.
• In a decreasing interest rate environment, you may pay less interest compared to fixed-rate options over the loan term.
• Penalties for breaking a VRM are typically limited to three months’ interest, avoiding the costlier interest rate differential (IRD) penalty associated with fixed-rate mortgages.

Cons:

• If interest rates rise, a greater portion of your payment goes toward interest, extending your remaining amortization.
• In cases of significant rate increases, some lenders may require conversion to a fixed-rate term to prevent further amortization extension, often resulting in a higher payment.

Good to know:

• VRMs allow for adjustments until reaching the Trigger Point balance.
• Adjustments may include converting to a fixed-rate term, increasing your payment, or making a prepayment to reduce your outstanding balance.
• It’s advisable to increase your payment when rates rise to maintain or reduce your amortization period.
• Using prepayment privileges or increasing your regular payment can create a buffer against future rate increases.

Adjustable-Rate Mortgage (ARM):
Your interest rate and mortgage payment change in tandem with the lender’s prime rate.

Pros:

• Often feature lower initial rates compared to fixed-rate mortgages, resulting in reduced monthly payments.
• If interest rates decrease, monthly payments reduce accordingly.
• Penalties for breaking ARMs are typically three months’ interest rather than the higher IRD penalty associated with fixed-rate mortgages.

Cons:

• Payments may increase if the lender’s prime rate rises, adding budgeting uncertainty.
• A substantial rise in interest rates could result in paying more interest over the loan term compared to a fixed-rate mortgage.

Good to know:

• Interest rates and payments change based on fluctuations in the lender’s prime rate.
• Payments decrease when rates fall, while the amortization period remains unchanged.

The choice between Fixed, Variable, or Adjustable rates depends on your comfort, budget, and unique circumstances. Choose a fixed-rate or VRM for certainty and consistent payments. Opt for an ARM if you’re aggressive in minimizing interest payments. Most lenders offer either VRM or ARM, not both. Have a candid discussion with me to understand the risks and rewards of each type. If your mortgage is maturing soon, reach out for personalized assistance in determining the best rate for you.