17 Feb

Fixed vs Variable Mortgage Products

General

Posted by: Michael Atkinson

Over the past year, I constantly get asked: “What’s the difference between a fixed rate and a variable rate?” I want to shed the light here on the differences between the two, and hope to give you a better understanding of both of them.

 

Fixed Rate: Your interest rate stays the same throughout the length of the term, thus being percieved as the “safe” way to go.

Variable Rate:  Just like it sounds – the interest rate is predicted by the Bank of Canada’s prime lending rate and can change up to 8 times a year. The variable portion is guaranteed by the lender to be either a premium or discount of the prime interest rate.

Let’s confirm a few facts about the Variable rate.

The interest rate cannot, and will not, spike randomly. There are 8 Bank of Canada meeting’s per year to determine whether to increase, decrease, or keep the prime rate the same.

The interest rate or your payments will not ‘double overnight’. It is very unlikely that the prime rate will change more than .25% at any of these BoC meetings. Is hasn’t changed since September 2010.

Statistically speaking, over the past 40 years, Canadians that enter into a variable rate always come out ahead. Those locking into a fixed rate generally end up paying more interest and less principle of their mortgage.

Prepayment Penalties

Most people overlook this portion of their mortgage, as they are only concerned about getting the best interest rate.

Statistically speaking, 6 out of 10 Canadians will break their mortgage at an average of 38 months into their 60 month term. 

In the case of a 5 year fixed term, the mortgage penalties are generally 3% of the mortgage balance. On a $100,000 mortgage, that is roughly $3,000.

A variable rate mortgage has much lesser penalties. Generally speaking it is 3 months of interest as a penalty. On average, they are about .70% of the mortgage. Given my example above, this equates to about $700 on a $100,000 mortgage.

There are many reasons why people break their mortgage. Divorce, spousal seperation, employement change, health issues, a variety of social issues, or desirability to leverage equity intheir property.

The short version is that clients currently in five-year fixed rate mortgages with 2-3 years left in their term are being hit with a prepayment penalty five times higher than clients in variable rate mortgages.  This after paying a higher interest rate all the way along as well.