How does a fixed-rate mortgage work?
A fixed-rate mortgage comes with a fixed term — the most common in Canada is five years — and a fixed interest rate, which doesn’t change. This means you will see the exact same payment every month (or whatever your payment frequency is).
At the end of each term, you will either have paid off the mortgage or you will have an amount still owing. Most homeowners need multiple terms to repay their balance, so they will have to renew their mortgage with the same lender or switch to a new one.
Pros of a fixed-rate mortgage
The main advantage of a fixed-rate mortgage is stability. Unlike with variable-rate mortgages, the interest you pay on the amount you borrow will stay the same for the entire term of the mortgage.
This means you have predictability in your cost of living. If your monthly mortgage payment is $1,250 at the start of the term, that’s exactly what it will be at the end.
You don’t get that predictability with rent. And with variable-rate mortgages, your monthly payment may change in step with your lender’s prime rate — a benchmark that varies depending on economic conditions.
Cons of a fixed-rate mortgage
Fixed-rate mortgages typically come with a higher interest rate than variable-rate mortgages. This means that, over the course of the mortgage term, you could end up paying thousands more in interest than you would have with a variable-rate mortgage.
Plus, if mortgage rates fall during the period of your mortgage term, people with variable-rate mortgages will see their interest payments fall, while those with a fixed rate will continue paying what they were paying before.
On the other hand, if mortgage rates go up, the reverse becomes true. Now fixed-rate mortgage holders will get the better deal.
5-year fixed mortgages
Five-year fixed-rate mortgages have traditionally been the most common type of mortgage in Canada, though the popularity of variable-rate mortgages has grown. Many borrowers feel five years is a good balance between the security of locking in a rate for a long time and the cost of doing so.
Benefits of a 5-year fixed mortgage
With a 5-year fixed rate, you get the predictability of knowing your mortgage payment will remain the same for the next 60 months. Consider it a form of insurance: You’re paying a little more than you might otherwise in order to protect you in the event of a costly disaster — in this case, a potential interest-rate hike. This stability can be especially enticing for homeowners on a budget.
5-year vs. 3-year
While a 3-year fixed rate is typically lower than a 5-year rate, some homebuyers may prefer the stability of having the same mortgage payment over a longer period of time. That said, if you’re unsure how long you will stay in the home, a shorter mortgage term may be ideal. Homeowners often have fantasies of finding their forever home on the first try but end up moving quicker than they expect.
Types of fixed mortgages
Fixed-rate mortgages come in two main types: open and closed. Closed mortgages tend to have lower interest rates, but you may be charged extra for paying off your balance early.
Closed mortgages are more popular because most homeowners don’t need the flexibility. If you’re not sure, you can also opt for a convertible mortgage.
An open mortgage is a home loan that comes with flexible terms for repayment. With an open mortgage, you have a lot of flexibility to make early payments or to pay out your mortgage altogether through a refinance or cash payment. The downside of this is that, generally, open mortgages have slightly higher interest rates than closed ones.
A closed mortgage comes with rigid terms for repayment. With a closed mortgage, you typically have little flexibility in terms of making early payments or repaying the loan in full before its term is up. That’s not to say those options are completely off limits, but you will typically be charged extra.
Some of the most closed mortgages will not allow you to refinance without significant penalty and will only allow you to pay off the mortgage early if you sell your property. Often the bank will ask you to pay three months’ worth of interest, or the difference in interest costs between what you’re paying and market rates today, whichever is higher.
A convertible mortgage comes with the option of changing some of the fundamental rules about your loan without refinancing, which can bring on significant costs and penalties.
For example, some convertible mortgages will allow you to switch from a fixed-rate mortgage with a very short term, like six months, to a much longer one. Other kinds of convertible mortgages might allow you to switch between an open and a closed mortgage, or between a fixed rate and a variable rate.
While convertible mortgages typically come with higher interest rates or a fee to make alterations, the flexibility they provide can be worth it if you believe interest rates or your personal circumstances may change in the near future.
How to get the best fixed rate
Getting the best interest rate you can on your mortgage is important, because even a small difference can amount to thousands of dollars over time.
Fixed-rate mortgages typically come in three-, five-, seven- and 10-year terms. Generally, the longer the term, the higher the rate — but it might still be worth it to get one of the longer ones, as they allow you to lock in a rate for many years.
Closed mortgages tend to have lower rates than open ones as well.
However, to get your bank’s best rate, you’ll need to prove your creditworthiness. That means having a good credit score, a relatively low amount of debt already outstanding and preferably a large down payment. Check out the tips below on how to get the best rate on your mortgage.
Boost your credit score
Your credit score is one of the key factors lenders use to determine the interest rates they offer — and whether to approve the loan at all. You’ll need a solid credit score to be offered the bank’s discount rate, which can be a few percentage points lower than the advertised rate.
There are a number of things you can do to improve your credit score. First and foremost, pay your bills on time. Then, if you’re carrying a balance on your credit card(s), try to pay off a somewhat large amount each month. Finally, check your credit report and make sure there aren’t any errors or outstanding collections under your name.
Lower your debt-to-income ratio
Your debt-to-income ratio is the total amount of debt payments you have to make each month, expressed as a percentage of your pre-tax monthly income. This number is crucial, because it helps determine how much a bank will lend you to buy a house. The lower your debt-to-income ratio, the more room you have to borrow for a mortgage.
There are only two ways to lower the debt-to-income ratio: increase your income or decrease your debt. Try making more cash purchases and fewer purchases on credit. Consider delaying or downsizing major purchases like a car or appliances. And keep an eye out for a better-paying job or a gig you could do on the side — so long as you’ll have proper documentation you can show your lender.
Save more for a down payment
One way to reduce the size of the mortgage you’ll need to buy a house is to save more for the down payment. If you manage to save enough (or get enough from relatives, as is often the case today) to put down 20% of the purchase price, you’ll be able to avoid mandatory mortgage default insurance, which often costs tens of thousands of dollars — an amount added to the mortgage you owe.
To increase your savings rate, you’ll need to establish a budget. There will be hard choices ahead, but don’t forget to check for easy wins. These days, many people waste money on subscriptions they rarely use or have even forgotten about. Check your credit card statements to see whether you’re paying for any streaming services, gym memberships or dessert-of-the-month clubs you don’t need.
Compare mortgage rates online
Before committing to a mortgage, you should be confident you are getting the best rate you can and that the terms are the right ones for your situation.
The main decisions to be made are: How long of a mortgage term do you want? (Typically, the shorter the term, the lower the interest rate.) Do you want a variable-rate loan or a fixed-rate loan? (Typically, variable mortgages will have somewhat lower rates, but fixed-rate loans offer more stability.) And finally, you’ll want to consider whether you are looking for an open mortgage with flexible terms, or a closed mortgage with more rigid terms but a lower rate.
Frequently Asked Questions
Is a fixed- or variable-rate mortgage better?
Fixed- and variable-rate mortgages both have their advantages and disadvantages. Many borrowers like the stability and predictability of a fixed-rate mortgage — it’s a lot easier to plan ahead when you know exactly what you will pay each month until the end of the mortgage term.
Others, however, prefer the lower interest rate that typically comes with a variable mortgage. Though the interest paid on the mortgage may rise and fall with the lender’s prime rate, it can often amount to thousands of dollars in savings compared to a fixed-rate mortgage.
Your choice will ultimately hinge on your financial means, your foresight and your stomach for risk.
Should I get a 3-year or 5-year fixed mortgage?
Typically, a three-year fixed-rate mortgage will come with a slightly lower interest rate than a five-year. That means savings on interest costs, but the risk is that, when you renew after three years, you might have to renew at a higher rate than the ones available today, meaning you could end up losing out overall.
A five-year fixed-rate mortgage locks your rate in for five years, giving you a longer period of predictable monthly payments than a three-year mortgage. But the risk here is that interest rates might fall over those five years, in which case you will be paying more in interest than you would have if you had renewed your mortgage after three years.
Can I refinance a fixed-rate term mortgage?
Yes, but the ease of doing so will depend on whether you have an open or closed mortgage.
Typically, open mortgages come with higher interest rates but give you lots of flexibility in terms of how the loan can be paid off. Depending on the specific terms, you may be able to make large early payments or even pay the loan off in a lump sum. There is usually no problem remortgaging an open mortgage.
Closed mortgages tend to have lower interest rates, but give you far less flexibility. Some of the most closed mortgages will not allow you to refinance without significant penalty and will only allow you to pay off the mortgage early if you sell your property.
Is it worth breaking a fixed-rate mortgage?
It can be, depending on your situation. If you have a lot of time left on a five-year mortgage, for example, and interest rates have fallen steeply, you could probably save yourself thousands of dollars by refinancing to a mortgage with a lower rate.
But be mindful of the penalty that may come with breaking a mortgage. With closed mortgages, often the bank will ask you to pay three months’ worth of interest, or the difference in interest costs between what you’re paying and market rates today, whichever is higher.
If you’re close to the end of your mortgage term, it likely won’t make sense to pay your lender’s charge for breaking your mortgage.
Can I pay off my fixed-term loan early?
That depends on the details of your mortgage. With an open mortgage, you have a lot of flexibility to make early payments or pay out your mortgage through a refinance or cash payment. That’s why they’re typically a bit more expensive.
Paying down a closed mortgage early can be difficult. You can face stiff penalties — often three months’ worth of interest or the difference in interest costs between what you’re paying and market rates today, whichever is higher. In some instances, your lender may only allow it if you sell your house.
Before you sign a mortgage, make sure you know which is best for you.
What happens when my fixed rate ends?
When the term of your loan ends, you will be in one of two situations: Either you have paid off your mortgage, in which case congratulations, or you have a balance outstanding on your mortgage. If that’s the case, you will need to renew your mortgage.
There are a number of ways to do this. Your current lender will probably make it very easy for you to renew with them – you might get the paperwork for it mailed to you, all neatly filled out, just awaiting your signature. But there’s a good chance you’ll get a better interest rate if you shop around.
Applying for a mortgage renewal with a different lender is more or less the same process as getting a mortgage from scratch.
But don’t forget to do something when the end of your mortgage term is nearing. If you don’t have a new mortgage in place by the time the current mortgage’s term ends, your lender will likely shift your outstanding balance to a short-term mortgage — with a very high interest rate.
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