Navigating Mortgage Rates: Fixed vs. Variable - Making the Right Choice for You

Choosing the right mortgage is a crucial step in the home-buying process. One of the primary decisions you’ll face is whether to opt for a fixed or variable mortgage rate. In this blog post, we’ll break down the key differences between the two options and provide insights to help you make an informed decision that aligns with your financial goals and risk tolerance.

Fixed vs. Variable Mortgage Rates:

Historically, fixed rates tend to be higher than variable rates. Fixed rates offer stability as they remain constant for a specified term. This makes them an excellent choice for those who prefer predictability and want to avoid fluctuations in their mortgage payments.

Fixed Rates and Government Bonds:

Fixed rates are closely tied to the government bond market, particularly the 5-year Government of Canada bond yield. Understanding this connection can offer valuable insights into how fixed rates may change over time.

Variable Rates and Risk Tolerance:

Variable rates, on the other hand, fluctuate with the current prime rate, sometimes with a discount applied. While variable rates are generally lower than fixed rates, they come with a higher level of risk. This option is better suited for individuals with a higher risk tolerance who are prepared to navigate potential rate fluctuations.

Types of Variable Rate Mortgages:

There are two main types of variable rate mortgages: Variable Rate Mortgages (VRMs) and Adjustable Rate Mortgages (ARMs). VRMs maintain static total payments, while the interest rate portion fluctuates with the prime rate. ARMs, on the other hand, have variable payments that change alongside the prime rate. With variable mortgages, you usually have the option of converting to a fixed rate at any time for an equivalent fixed term for the amount remaining on your mortgage.

Understanding Trigger Points:

With VRMs, there’s a concept of a trigger point, which occurs when the prime rate rises to a level where the entire mortgage payment goes towards interest, leaving none for the principal. ARMs do not have trigger points, but they do entail fluctuations in the total payment.

Prime Rate and Financial Institutions:

The prime rate is determined by financial institutions, while the overnight rate is set by the Bank of Canada. Typically, financial institutions adjust the prime rate in tandem with changes in the overnight rate, maintaining a consistent gap between the two.

Prime Rate Fluctuations:

As of October 27th, 2023, the overnight rate is 5%, and the prime rate stands at 7.2%. It’s worth noting that the prime rate is always higher than the overnight rate. For instance, between March 2022 and October 2023, TD’s prime rate surged from 2.7% to 7.2%, reflecting a significant 166.67% increase.

Breaking Your Mortgage:

Breaking a mortgage can incur penalties, and the costs differ between fixed and variable rate mortgages. Generally, it’s less expensive to break a variable rate mortgage, often carrying a 3-month penalty. In contrast, fixed rate mortgages may involve a penalty calculated as the greater of a 3-month penalty or the Interest Rate Differential (IRD). If you anticipate the possibility of breaking your mortgage at some point during the term (perhaps you plan on selling in the near future), a variable mortgage may make more sense, as the penalty for breaking it will be much less.

HELOCs and Prime Rates:

HELOCs (Home Equity Lines of Credit) also have interest rates tied to the prime rate, emphasizing the importance of understanding this key metric.

In conclusion, the choice between fixed and variable mortgage rates depends on your risk tolerance and financial needs. While hindsight may provide clarity, making the best decision at the time is what matters most. By weighing the pros and cons outlined in this blog post, you’ll be better equipped to select a mortgage product that aligns with your unique circumstances.