How Rates Work

Fixed or Variable rates? Which one is right for me? There are many factors to consider and it isn’t a simple question to answer. Our clients need to understand how they work-and we are going to show you! First, let’s start with the basics.
 
Fixed vs. Variable-what’s the Difference?
 
Fixed Rates will have an interest rate that will remain the same throughout the entire term of the loan. Fixed rates are also dictated by the bond market, which is based on the world economy. As bond yields increase or decrease, the fixed rate mortgage will reflect the changes. So, if the world economy is unstable, investors will put their monies into the bond market and rates are low. If the world economy strengthens, investors will put their monies into these countries and out of the bond market and rates will be higher.
 
Variable Rates, on the other hand, will fluctuate with changes in the prime rate and the interest and principle portion of the payment may vary. Variable rates are based on the Bank of Canada’s Overnight Lending Rate which is dictated by the Canadian economy. A weak or unstable Canadian economy will remain low to stimulate buying. A strong Canadian economy though will foster higher rates to slow down buying.  The Bank of Canada has eight fixed dates each year where it can announce if there will be any changes in the Prime lending rate.
 
So, What Are the Pro’s and Con’s of Each?
First, let’s start with a fixed rate:
PROS

1. You have stability for the term of your mortgage. Your mortgage payment will remain the same and there will be no change to your payment each month.

CONS

1. A fixed rate is typically higher than a variable rate.
2. If you break the term of your mortgage you may be charged an IRD (interest rate differential) Penalty. An IRD penalty can be a significant cost and it is typically ~4.7% of the balance. This works out to $4,700.00 for every $100,000.00 that you have borrowed.

Next, let’s look at a variable rate:
PROS

3. A variable rate is typically lower than a fixed rate.
4. Statistically, a variable rate has outperformed the fixed rate for the last 40 years.
5. You have the option to lock into a fixed rate at any point in the term of your mortgage at no cost
6. If you break the term of your mortgage early, your penalty is 3 months’ interest

CONS

1. Your rate will change as the Bank of Canada adjusts the Prime Rate
2. Pending on the lender your payments can fluctuate.
3. As prime rate changes, the amount going to interest and principle will vary.

 
What Factors Impact the Rate?
There are a few factors that you also have to consider as they will have an impact on the rate. These include:

1. Is the mortgage insured (you are putting down less than 20% of the purchase price) or uninsured (you are putting down more than 20% of the purchase price)?
   • Insured mortgages mean you will have best discounted rates
   • If you have an uninsured mortgage then your rate will be higher than if the mortgage was insured
2. How long is the amortization?
   • If your amortization exceeds 25 years you will pay a rate premium for the longer amortization
3. Who is the lender?
   • Each lender has their own unique and competitive pricing.
4. What is your credit score?
   • There are tiers when it comes to your credit score. The higher your credit score the more competitive rate that you can expect to get.
5. What does your credit history look like?
   • Your credit history will also impact your rate. If you have a previous bankruptcy or consumer proposal you are likely looking at higher rates.

 
Finally-Which rate is BEST for me?
That is a personal question that is individual for each client. A variable rate historically has been lower than a fixed rate and the Bank of Canada does not make significant changes to the prime rate. When the BOC adjusts prime it has been a 0.25% drop or increase. A 0.25% change in prime rate would impact your mortgage payment by $13.00/$100,000.00 each month. Another consideration? The last drop rate for BOC on record was July 2015 and the last increase on record by the BOC was September 2010.
 
So with all that the best advice we can give you is to speak to a mortgage professional. They can guide you and direct you towards the best option for you and your unique situation.