What is the difference between Fixed Rate, Variable Rate and Adjustable-Rate mortgages?

Buying a home will be one of the biggest purchases you will make in your lifetime and with it comes your quest to find the lowest interest rate you could get in terms of financing. I’ve seen clients from different walks of life ask me what’s the best rate I can offer and with that I usually respond with a question myself; “Well, what type of rate are you looking for?”.

Homebuyers often get caught up with the lowest rate they see without considering what type of rate best suit their needs. This way of decision-making end up costing them more money because clients later realize that the rate type they chose may not be the best option for their future plans.

I have outlined below the definition of each rate type as well as their advantages and disadvantages.

FIXED RATE

A fixed rate mortgage entails having the same interest rate throughout the course of the mortgage term. In effect, your mortgage payment stays the same over the entire term. I emphasize on the word term because all rates offered for mortgages in Canada change every term and thus, you cannot keep the same rate for the whole duration of the mortgage.

Advantage

A fixed rate mortgage provides clients with stability; knowing that your payments will not change, and you only need to set aside the same amount every time your mortgage payment is due to be debited. This in turn, gives you an opportunity to save more and pay down your mortgage at a uniform pace.

Disadvantage

The only time a fixed rate mortgage will work against you is if you decide to payout your mortgage prior to the term maturing. This is because the penalty to break a fixed rate mortgage is higher than the other two interest types. You also cannot switch from a fixed rate mortgage to a variable rate or adjustable-rate mortgage.

Ideal Use

Clients who plan on keeping their homes for a very long period or at least until the end of the term would benefit from a fixed rate mortgage since plans of breaking it early is almost non-existent.

VARIABLE RATE

A Variable rate mortgage roots from the word “vary” which is the very essence of the rate type. The payment going to interest and principal changes every time the prime rate changes; however, the total monthly payment remains the same. This means that your mortgage payments almost always stay the same until you reach the trigger point. A trigger point is determined by your lending institution and usually happens when the Prime Rate has grown so large that there is no more payment being remitted towards the principal balance of your mortgage. When this point is reached, your monthly payment will be adjusted.

Advantage

A variable rate mortgage may cost less to break compared to a fixed rate mortgage and still offers the same stability of a fixed rate mortgage.

Disadvantage

When the trigger point in this rate type is reached, it becomes very problematic and could cause borrowers to have to pay a lump sum to cover the unpaid principal or interest.  

Ideal Use

This rate type benefits clients who are looking for that stable monthly payment but have plans of breaking the mortgage early; thereby incurring less in penalties.

ADJUSTABLE RATE

An adjustable-rate mortgage operates on a lot of flexibility. The mortgage payment adjusts every time there is a change in the Prime Rate. This ensures that the same amount of payment is made towards the principal balance of the mortgage regardless of what interest rate is being charged. 

Advantage

Like a variable rate, the penalty to break an adjustable-rate mortgage is cheaper compared to a fixed rate mortgage. It also allows you to enjoy paying off your mortgage balance at a uniform pace regardless of prime rate fluctuation.

Disadvantage

Should the prime rate increase drastically, the mortgage payment for this rate type could become too expensive and unmanageable if the borrower does not monitor the prime rate fluctuation prudently.

Ideal Use

The ideal client for this rate type is typically one that is an experienced investor and have surplus cash flow that could support any fluctuation that could happen on the mortgage payment because of a change in the prime rate.

Contact us today for a free consultation. Leveraging over twenty years of industry experience, we can plan your way forward and achieve your goal of being a homeowner the smart way.