The Difference Between Variable and Fixed Mortgage Rates

Mar 8, 2016

When shopping for a mortgage you will have a lot of questions. 2 of the most prominent questions mortgage brokers receive are ‘What are your best rates?’ and ‘What is the difference between variable & fixed rates?’

What are your best rates?

This is actually a lot more complicated than the second question.  Why?  Because rates are not the only thing you should be looking at when deciding what mortgage product to contract to.  Recently, a client brought us a product that had a 1.99% fixed rate for a 5 year fixed term.  This was extraordinary.  And we did our due diligence to see what the product was all about.  We found out that the term was 5 years and the interest rate was fixed at 1.99%…..for the first 6 months.  Then it went up to the posted fixed rate of 3.15% for the remainder of the term.  Not nearly as stellar as it appeared.  Rule of thumb.  If it is too good to be true, it is too good to be true!  Make sure you know what your mortgage product entails.  It is in your best interest to find out all the hidden costs behind the mortgage product that you don’t see up front.
This leads us to the second question:

What is the difference between variable & fixed rates?

Fixed Rates
For the bank, this is a lower risk.  It is usually higher than a variable rate.  It remains constant or fixed for the term of the mortgage which means that your payments remain constant for the term of the mortgage.  This rate is based on typical rates that are being offered by banks at the time the client enters into the mortgage contract.  It’s a lot like “gas wars”.  When you see gas stations that are in close proximity lower and raise their prices based on what the gas station across the street is doing, you see that these gas stations are competing with one another.  It’s the same with banks.  They watch each other’s prices and react to what’s going on “across the street”.
Variable Rates
This is a higher risk rate for the bank.  It is harder to qualify for this rate, which means the bank allows less debt in your financial profile compared to qualifying for a fixed rate.  A variable rate can change during the term of the mortgage which means your actual mortgage payment can either increase or decrease during the term of the mortgage.

A variable rate is also a higher risk for the client as rates can go up which directly affects your payment amount.  The last 15 years has seen rates generally decrease and clients that have taken advantage of the variable rate have not seen an increase in mortgage payments.  But that’s not to say that it can turn at any time.  Historically, we are at the lowest rates that we’ve seen.  No one has a crystal ball.

Variable rates are quoted as Prime Rate minus a certain amount or Prime plus a certain amount.  What does this mean?  Variable rates are based on the Bank of Canada, a governing institution for all Canadian banks.  The Bank of Canada sets the benchmark for interest rates, based on inflation.  Generally speaking, if the economy needs to be stimulated and is in a state of deflation, interest rates along with the Canadian dollar are lower.  If the economy needs to be slowed down and is in a state of inflation, interest rates are higher along with the Canadian dollar.  Currently, the benchmark rate for the bank of Canada is 2.5%.  But most banks have adopted 2.7% as its Prime rate, basically because 2.5% is just too low for the bank.  Thus, a bank might offer you Prime minus 0.2% (2.7% – 0.2% = 2.5%).  Remember, the Bank of Canada reviews its benchmark rate about 8 times a year.  Depending on the state of the economy, they may raise or decrease the benchmark rate which will affect your variable rate.

An example:
You enter into a contract rate of Prime – 0.2% (2.5%).  18 months later, there is a surge in foreign investment into the country which stimulates the economy.  The Bank of Canada reviews its benchmark rate and decides to raise the benchmark rate to 2.75%.  Your bank follows suit and raises its Prime rate from 2.7% to 3%.  Your contracted rate for your mortgage is still Prime – 0.2%.  But instead of 2.5% you are now paying 2.8%.  Your mortgage payment will also go up to reflect the new rate.

For more information about fixed and variable rates please give us a call.  We’d be pleased to answer any questions you have.

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