When you're ready for a mortgage, you'll have to decide whether to go variable or fixed.
With a fixed rate mortgage, your interest rate and monthly payment will stay the same
across your term. With a variable rate on the other hand, your interest rate and monthly
payments are likely to fluctuate over the course of your term. We've brought in mortgage
broker Ian MacKay to walk you through both types of rates and show you the differences
in more detail.
As Alyssa mentioned, your variable rate mortgage will start with a lender's prime rate. The
lender will either offer you a premium or a discount to their prime rate.
In this illustration, your lender has offered you a variable rate mortgage at a discount
of Prime minus point-four-five per cent. With the current prime rate of three percent, your
effective interest rate for your variable rate mortgage is two-point-five-five per cent.
If the prime rate were to increase to four per cent, your effective interest rate would
be three-point-five-five percent. And if prime rate increased to five percent, your effective
interest rate would be four-point-five-five per cent.
Important points to consider are that your relationship with Prime never changes throughout
the term, and that Prime can change based upon the bank's overnight lending rate.
Let's say you just purchased a home for three-hundred-thousand, and have a five per cent down payment. In
this example, with a five year fixed interest rate of two point nine per cent you would
have a monthly mortgage payment of one-thousand-three-hundred-seventy-five-dollars. With a variable rate mortgage, with an effective
interest rate of two-point-five-five per cent, you would have a monthly mortgage payment
of one-thousand-three-hundred-nineteen-dollars. In this example, the variable rate mortgage
payment is less; however you must consider that your payment can fluctuate throughout
the length of the term. Two years into your term, Prime has increased
to four per cent. What that means is the effective interest rate of your variable rate mortgage
has increased to three-point-five-five per cent. That also means that your effective
monthly mortgage payment has increased to one-thousand-four-hundred-seventy dollars.
Now, let's look at how much these interest rates would cost you over a five-year term
since fixed interest rates remain the same over five years we simply multiply the payment
over sixteen months. That would give you an effective mortgage payment over five years
of eighty-two thousand-five-hundred-dollars. For the variable rate, we must take the payments
for the first two years when the rate was two-point-five-five per cent and then calculate
the payments for the last three years when the rate was three-point-five-five per cent.
The payment for the first two years is thirty-one-thousand-six-hundred-fifty-six-dollars, and the payment for the last three years was
fifty-two-thousand-nine-hundred-twenty dollars, for a total of eighty-four-thousand-five-hundred-seventy-six
dollars. In this example, payments for the five-year
fixed are lower than the five-year variable rate. However, that is not always the case.
For the sixty per cent of Canadians that prefer the stability of a fixed interest rate, variable
rate interest rates have been lower over the past ten years.
A fixed-rate provides stability and eases budgeting anxiety because it is constant over
the creation of the term. However, when the fixed rate is significantly higher, the stability
is often not worth the premium.