Fixed and Variable Mortgages: Everything You Need to Know About Fixed and Variable Mortgages
Whether you’re purchasing a new home or refinancing your existing one, chances are you’ll have to make an important decision regarding your mortgage. A mortgage is probably the largest loan you’ll ever take out in your life, so it’s crucial to understand what you’re getting into.
For years, Canadians have been asking themselves whether to go fixed or variable. The decision largely depends on your income, lifestyle and how much risk you’re willing to take. We’ve come up with a guide to help you understand the differences of each. It also lays out the factors to consider when determining which option is right for you.
Historically speaking, interest rates on variable mortgages have traditionally been cheaper. According to historical data from a division of CIBC mortgages, the rate in May 2004 for a fixed mortgage was 5.82%. But the rate during this time for a variable mortgage was 3.75% — a considerable difference. This trend of interest rate gaps has continued for over a decade with variable mortgages proving to be the cheaper option — most of the time.
Making a decision on your finances, however, isn’t always so black and white. Just because the interest on one mortgage is lower, this doesn’t necessarily mean it’s the right option for you. There are many other factors to take into consideration, which we’ll explore going forward.
Fixed vs. Variable: Comparison of Monthly Payments
Let’s say you’re taking out a mortgage of $400,000 with a fixed rate of 3.19%. In this scenario, you’ll pay about $1,932 per month. Over the next 5 years, this equals a total payment of $115,920.
Now, let’s calculate the same terms under a variable mortgage. If your variable rate is 2.69%, your monthly payment would be about $1,830. Over the next 5 years, your total payment would be $109,800. When compared to a fixed rate mortgage, you’d be saving about $6,120.
An interest rate difference of even half a percentage point can save you thousands of dollars in the long-run. However, the main drawback is the risk involved. The interest rate on a variable mortgage could rise or fall without warning at any time.
Assessing Risk: Can you afford a rate increase?
When making a decision, it’s important to assess whether your financial circumstances can handle a rate increase. Even a small rise can have a significant impact on your monthly payment. That’s why households with little savings or tight budgets may be inclined to stick with a fixed mortgage rate instead. Here are some questions to ask yourself:
- Can my current income cover some level of financial risk?
- What potential is there in the future for an increase in my earnings?
If you’re leaning towards a variable mortgage, calculate whether you can comfortably afford interest rates that are two percent higher than what you’d pay on your current variable. In Canada, rates are still at historic lows. So low, in fact, that it’s quite realistic to assume they could rise considerably going forward.
Emotional Impact: Does this mortgage fit my personality?
Understanding the risk involved in variable mortgages is just the beginning. Even if you’re determined you can financially afford an increase in rates, you’ll still want to decide if a variable mortgage is in line with your personality. If you’re the type of person who will be emotionally affected knowing your rates may go up, even slightly, then a variable option may not be ideal for you.
The main takeaway is that a fixed mortgage offers peace of mind whereas a variable rate is suited for those with higher risk tolerance. Mortgage contracts are typically up for mortgage renewal every five years. So, whatever decision you make today will not only impact your finances but your psychological future too.
Understanding Open vs. Closed
Within the realm of fixed and variable mortgages, there is a subset of terms that must also be understood. Mortgages come with an extra set of rules, largely centred around payment flexibility. Open and closed terms can be applied to both fixed and variable mortgages:
Open: Allows you to put down as much as you want or pay off the entire mortgage at any time, without charge
Closed: Payments are generally fixed for the term; prepayment options are usually very limited.
Just as fixed mortgages are better for those seeking stability, a closed term is ideal for the budget-conscious homeowner who prefers long-term peace of mind.
Why Choose Butler Mortgage?
Despite learning all the differences between a fixed and variable mortgage, there’s no harm in asking a mortgage professional to help guide you through the decision-making process. At Butler Mortgage, our friendly brokers are dedicated to protecting your best interest. For unbiased and helpful advice, rely on our experts to connect you with the best mortgages on the market today.
For more information on fixed or variable rate mortgages, call Butler Mortgage at 1-866-728-6870 or contact us here.