Variable vs. fixed rates

There are two basic types of mortgages in Canada: Variable-rate mortgages and fixed-rate mortgages. Which one you have will affect your monthly payments, as well as potentially the amount of time it takes for you to pay off your mortgage. So it’s important to understand the difference between them.

With a variable-rate mortgage, the interest rate you pay changes with the bank’s prime rate – the interest rate the bank offers its best customers. If the prime rate rises, your interest costs rise with it.

If you have an uncapped variable mortgage, you will see your monthly payments increase if interest rates go up, and decrease when interest rates go down. With a capped variable mortgage, your monthly payment will remain the same, but if the prime rate rises, more of your payment will go to interest, delaying the day when you finally pay off the mortgage. And the reverse is true if the prime rate falls.

With a fixed-rate mortgage, the interest rate is guaranteed for the term of the mortgage. The most common mortgage term is five years, but you can get fixed mortgages for as little as two years, or as many as 10.

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How does a variable-rate mortgage work?

A variable-rate mortgage comes with a fixed term (typically three or five years) and a variable interest rate, which changes according to your lender’s prime lending rate. Its interest rate is expressed, for example, as “prime plus one.” That would mean your rate is whatever the bank’s prime lending rate is, plus one percentage point. So if the prime rate is 3%, your mortgage rate is 4%. If the prime rate drops to 2.5%, your mortgage rate drops to 3.5%.

If you have a capped variable mortgage, your monthly payment will stay the same, but the amount that goes to paying interest will rise and fall with interest rates. This can delay, or speed up, the day you finally pay off your mortgage. With an uncapped mortgage, your monthly payments will rise or fall with the bank’s prime rate, but your repayment schedule will stay the same.

At the end of the mortgage’s term, you will either have paid off the mortgage, or you will have an outstanding amount still owing. If that’s the case, you will have to get a mortgage renewal.

Pros of a variable-rate mortgage

The main upshot of a variable-rate mortgage is that it typically comes with a lower interest rate than fixed-rate mortgages, meaning you can save thousands of dollars in interest payments over the course of the mortgage term.

A variable-rate mortgage also allows you to take advantage of falling interest rates. When lenders’ prime lending rate drops (which happens typically when the Bank of Canada lowers its key lending rate), your mortgage rate will drop with it. This means you could potentially pay off your mortgage faster than scheduled.

That’s not the case for fixed-rate mortgages, where you will keep paying the same rate until the end of the mortgage term.

Cons of a variable-rate mortgage

The main argument against variable-rate mortgages is unpredictability. If interest rates go up during your mortgage term, you could end up paying thousands more in interest than you would with a fixed-rate mortgage.

If you have a capped mortgage with fixed monthly payments, you won’t see a change in what you pay each month, but you’ll end up owing more at the end of your mortgage term. With an uncapped mortgage, your monthly payment will rise when rates do, potentially putting a squeeze on your household finances, but at least the amount owing at the end of the mortgage term won’t change.

5-year variable mortgages

Variable-rate mortgages in Canada most commonly come with a three- or five-year term. When you sign on to a five-year variable mortgage, you are committing yourself to making payments for 60 months. Those payments may change from month to month — if your variable-rate mortgage is uncapped — or they may stay the same, but with differing amounts going toward interest depending on the rate.

You can generally break out of a variable-rate mortgage, though there may be penalties, which will be determined by whether the mortgage is open or closed.

5-year variable open mortgage

A five-year variable-rate open mortgage is a home loan that comes with a five-year term and an interest rate that changes with the lender’s prime rate. There is also a lot of flexibility to make early payments, or pay out your mortgage through a refinance or cash payment. The downside of this flexibility is that, generally, open mortgages have slightly higher interest rates than closed ones.

5-year variable closed mortgage

A five-year variable-rate closed mortgage is a home loan that comes with a five-year term, an interest rate that changes with the lender’s prime rate, and generally 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. You may be charged extra for these changes.

Some closed mortgages don’t allow you to refinance your mortgage, and will only let you pay off the mortgage early if you sell your property. Closed mortgages are more popular than open mortgages in Canada, because they come with lower rates, and many homeowners don’t need the flexibility of an open mortgage.

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Getting the best variable rate

It’s important to get the best interest rate you can on your mortgage, because even a small difference in the rate can amount to thousands of dollars in interest charges over the course of a home loan.

Variable-rate mortgages typically come with three- or five-year terms. Currently, five-year variable mortgages have lower rates than three-year ones, but that’s not always the case. Closed mortgages tend to have lower rates than open ones as well.

However, you’ll need to prove your creditworthiness if you want a more favourable interest rate. That means your credit score needs to be solid, and you need to have your debts under control. Check out the tips below on how to get the best rate on your mortgage.

Check your credit score

Credit scores are among the things lenders use to determine the interest rates they offer to borrowers. You’ll need a certain minimum credit score to be offered the bank’s discount mortgage rate, which can be a few percentage points lower than the advertised (or posted) rate.

The first thing to do is check your credit score to see where you stand and make sure there aren’t any outstanding collections on your account.

There are a number of things you can do to improve your credit score. First and foremost, pay your bills on time. If you’re carrying a balance on your credit card(s), try to pay off a somewhat large amount each month.

Pay down your debts

Paying down your debts will give you a lower debt-to-income ratio, which can qualify you for a better rate or a larger mortgage.

Paying down your debts faster usually means spending less. The first thing to do is establish a budget. Then, look for ways to cut back.

If you’re like many other people today, you may be wasting money on subscriptions you 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 hot-sauce-of-the-month clubs you don’t need.

Increase your down payment

One way to reduce the size of the mortgage you’ll need to buy a house is to increase the size of the down payment. If you manage to put down 20% of the purchase price, you’ll avoid mandatory mortgage default insurance, which typically costs tens of thousands of dollars and is added to the debt you owe. That’s one reason many people these days are hitting up their parents for the cash for a larger down payment.

Compare mortgage rates online

You’ll want to be sure you know what your options are before you commit to a mortgage.

There are many decisions to be made. Should you pick a variable-rate loan (usually with a lower interest rate) or a fixed-rate mortgage (with a slightly higher interest rate)? You’ll have to decide whether you want to pay slightly more in interest for the convenience of a flexible open mortgage, or whether a closed mortgage with rigid terms is worth the savings in interest.

Then, you’ll have to choose a term: Three years? Five years? If it’s a fixed-rate mortgage, you can go up to 10 years. Each term length will come with different rates. For this reason, you’ll want to compare mortgage rates.

Frequently Asked Questions

Can I lock in a variable rate?

If you have a variable-rate mortgage, your interest rate will go up or down with the bank’s prime lending rate. Locking in the rate you have, while keeping that exact mortgage, isn’t usually possible.

But most borrowers with a variable-rate mortgage have some options if they want to lock in a low rate. If you have a convertible mortgage, your lender will allow you to switch to a fixed-rate mortgage without penalty, though that fixed rate may not be quite as low as your variable rate.

If you don’t have a convertible mortgage, you might still be able to refinance your mortgage, depending on how closed or open the conditions are. If your mortgage allows it, you may want to go to another lender to refinance, as they will often offer a better rate to new customers.

Why are variable rates higher than fixed?

Currently in Canada, variable rates are not higher than fixed; in fact, it’s the other way around. However, it can happen that variable-rate mortgages have higher rates than fixed-rate mortgages.

This is because variable-rate mortgages are largely tied to the Bank of Canada’s key lending rate, while fixed-rate mortgages depend on rates in the bond market, particularly the interest paid on Government of Canada bonds. This means fixed rates and variable rates can move independently of each other.

Can I remortgage on a variable mortgage?

Remortgaging means changing the mortgage on your property. It typically involves finding a new lender who pays out the old mortgage, leaving you with the new mortgage to pay.

Whether or not you can remortgage a variable-rate mortgage depends on the specific conditions of your mortgage. Typically, “open” mortgages will allow you to do things like make large early pre-payments, or pay off the mortgage in a lump sum. If that’s the case, you can remortgage.

But with “closed” mortgages there is far less flexibility. You may be limited in your ability to make early payments, and you may not even be allowed to pay out the mortgage unless you are selling the house. For this and other reasons, you should be clear on all the conditions of your mortgage before you sign.

Can I switch my variable rate to fixed?

If you have a convertible mortgage, your lender will allow you to switch from a variable to a fixed rate, without penalty, after a certain period of time.

If you don’t have a convertible mortgage, whether or not you can switch from your variable-rate mortgage to a fixed-rate mortgage depends on how open or closed your loan is.

With an open mortgage, which typically comes with a slightly higher interest rate, you have a lot of flexibility to pay down or pay off your loan in advance. In most cases this will be through a refinance. If that’s the case, you can shop around for a fixed rate. Keep in mind, though, that fixed rates are currently higher than variable rates.

If you have a closed mortgage, this may not be possible. Whether or not your lender allows you to refinance in the middle of the mortgage term, without selling the house, could be at their discretion. That’s one of the many reasons to be absolutely sure of your mortgage’s terms before signing on the dotted line.


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