Fixed or variable rate mortgage: which is better?

October 9, 2017 | By | Add a Comment

fixed or variable rate mortgageFixed or variable rate mortgage: is rate the only thing to look at?

One of the biggest questions you’ll face when planning your mortgage, is whether to lock in to a fixed rate or choose a variable rate mortgage. Currently, the 5 year fixed rate is around 3.44%, give or take a bit. You can get a variable rate in a range in the ballpark of prime minus .35% to prime minus .75%.  Since the prime rate is 3.2% right now, that makes your starting rate with the 5 year variable somewhere around 2.45 – 2.80%.  So what’s the catch?  What else should you know about deciding on a fixed or variable rate mortgage?

You can save money going variable, but not 100% of the time

Studies by financial experts such as Dr. Moshe Milevsky of the Schulich School of Business suggest that, more than half the time, you can expect to save money by going variable. Depending on how you look at the numbers (google to find his study from 2001), 65-80% of the time you would save money. BUT, and this is a very big “but”, many of the studies that show this savings were conducted in the predominantly falling rate environment we’d been seeing up until the last few years. Today, we’ve already seen rate increases. Many experts are predicting more to come.  So, you may be better off locking in your rate at this point in time. And to make this even more confusing,  mortgage rates are impossible to time perfectly or to predict with 100% accuracy.  It’s just like trying to time investing in the stock market.  So how do you decide?

Points to consider when deciding on a fixed or variable rate mortgage

1. Run some financial scenarios, or have a mortgage professional help you to run some.

Consider the prime rate rising 1-2% over the next five years. Then calculate what that does to your variable rate and the amount of interest that you’ll pay, versus locking in.

2. Set your payments as if you’ve chosen a fixed rate mortgage, but go variable.

This enables you to pay down the principal much faster, decreasing your amortization (the time it takes to pay down your mortgage to zero). If rates do go up, you’ll be paying a higher rate, but the amount you’ll owe will be smaller, so the negative impact is smaller.

3. Have your cake and eat it, too.

Several lenders have a mortgage product that allows you to lock in a portion of your mortgage in a 5 year fixed, but keep the other portion variable. This gives you the best of both worlds and allows you to hedge your bets. You can always lock in the variable portion later if there’s a nice drop in rates, or, conversely, if you believe that rates are about to hike up.

4. Consider your real estate plans.

Might you be paying off your mortgage early?  Or are you likely to be moving, or doing anything where you might need to break your mortgage term early? If that’s the case, you might be better off with a variable rate mortgage. Your prepayment penalty is limited to 3 months’ interest, rather than the “interest rate differential” that is applied on fixed rate mortgages.

5. Evaluate your risk tolerance.

If choosing a variable product means that you’ll be stressed and unable to sleep at night because you’re worrying about the mortgage rates, then it’s not worth the potential savings.  You are allowed to convert your variable rate mortgage to a fixed rate at any point during your term.  But, the rate is generally not as favourable as what you’d be offered initially.  If you think you’ll be tempted to obsessively watch mortgage rates with your hand on the “convert-to-a-fixed rate” trigger, then just go with a fixed rate at the outset.  Save yourself the wrinkles. 🙂

6. Make sure you qualify for the mortgage amount you want at the “stress test” rate.

Talk to your mortgage broker about this one.  You might qualify for more money if you take a fixed rate mortgage.  The Canadian government has ruled that mortgage lenders must use the stress test rate if you’re picking a 5 year variable rate (or anything less than a 5 year fixed rate mortgage).  The rule is that the mortgage lender MUST use the “posted rate” to determine if you qualify for the mortgage.  The exception (for now) is if you’re not choosing a 5 year fixed.  Currently the posted rate is 4.89%. So, if you’re not locking in to a five year fixed mortgage (at, say, 3.44%), even if the actual rate on the mortgage is less than the five year fixed, you must qualify for a 4.89% mortgage. This may rule out the variable rate option for you in the short term.

If you have your heart set on a variable, but you don’t qualify, you have to either get a bigger down payment, cut back on your budget for the home you’re buying, or bite the bullet and get a five year fixed. Don’t despair. At renewal time, you should be able to choose whatever you want.

Any questions – please don’t hesitate to get in touch!

For more info on this topic, check out my post, Understanding Mortgage Rates.


Image courtesy of renjith krishnan at

Filed in: First Time Homebuyer, Mortgage Planning, Purchase, Refinance | Tags: , , ,

About the Author (Author Profile)

I'm a Toronto Mortgage Broker. My focus is on saving people time and money in financing and re-financing their homes. Am passionate about helping people make informed choices, giving back, and helping to improve financial literacy in Canada.

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