Fixed vs. Variable Rates
As of December 1, 2016, the Canadian Federal Government changed the debt ratio calcualtion rules for both Fixed and Variable Rate mortgages where the client's debt ratios have to be within guidelines using the Bank Of Canada Qualifying Rate of 4.79% (also known as the bank's Posted Rate). This does not mean you would pay 4.79% on your mortgage, it is simply a way for the lenders, and you, to make sure that you can still afford the mortgage payments if the interest rate is higher when your mortgage comes up for renewal at the end of the mortgage term. This is often also called the Posted Rate.
A Fixed Rate mortgage has an interest rate that does not change during its' term. Therefore, your payment will remain consistant through the term. Fixed Rate mortgages have 1, 2, 3, 4, 5, 7, and 10 year terms. Most Canadians choose a 5-year term for its' balance of low rate over a reasonalble length of time.
As the name "Variable" suggests, the interest rate may increase or decrease during the term. Variable Rates are based on the Bank of Canada Prime Rate which is sitting at 2.45% today. Our lenders typically offer a discount off this rate of between 0.40% and 0.50%. Therefore the Variable Rate would usually be somewhere between 1.95% and 2.05%.
Variable Rates do not change from day to day. In fact, they may not change at all during the term. The Bank Of Canada has only 8 Interest rate announcements each year. You can see the Bank of Canada scheduled rate announements at the Bank Of Canada website. Between 2011 and 2014, the Prime rate remained the same at 3%. In January 2015 the Prime Rate dropped to 2.85% and in July 2015 the Prime Rate dropped again to 2.70%. In 2018 & 2019, the Prime Rate crept up to 3.95%. In 2020, due to the COVID-19 virus and its economic impact, the Prime Rate has dropped to 2.45%,
The Prime Rate is essentially based on the Canadian Economy, but more specifically the Canada Mortgage Bond. You don't have to be a financial expert to have some idea of how good or bad the Canadian economy is doing. Generally speaking, if the economy is doing poorly, the Prime Rate will remain low. And, if the economy is doing well, the Prime Rate will move higher. Therefore, the Canadian Prime Rate is expected to remain at it's current 2.70% until the last quarter of 2017. This makes the Variable Rates a great choice for your mortgage. If you would like more info on the Canada Mortgage Bond program, you can find the full details at the CMHC website.
Variable Rates have a couple of interesting features. If you hear that the Prime Rate is going to increase and you are worried about how that will effect your mortgage payment, you have the option to convert your Variable Rate into a Fixed rate at any time without any penalty. When you convert, you have to keep the remaining term the same or longer and you would be likely be moving to a higher Fixed rate. Please give us a call before you convert to make sure converting makes sense for you.
The other feature/benefit of a Variable rate is that the Penalty to break the mortgage during the term would only cost you 3 months interest. A 3 month interest penalty on a $237,500 mortgage with a 2.50% interest rate is only about $1,700. You can see that this penalty is substantially lower than the Fixed Rate penalties below.
Penalties to break and pay off a Fixed Rate mortgage during the mortgage term are calculated based on the greater of 3 months interest OR the Interest Rate Differential (IRD) penalty. For example, if you wanted to break your mortgage that has a 5-year fixed rate of 2.49% after 2 years (you would have 3 years left on the mortgage), the penalty to break the mortgage is calculated differently by different banks (presuming the 3-year rate is 2.39%). You can see there is a huge difference!
- Broker Mortgage Lenders calculate their IRD penalty like this:
- (Your Discounted Mortgage Rate - Current Rate for Remaining Term) x Mortgage Balance x Remaining Term in years. For example: (2.49% - 2.09%) x $237,500 x 3 Years = $2,850.00.
- The Big Banks calculate their IRD penalty like this:
- (Posted Rate when you got your mortgage - Current Rate for Remaining Term) x Mortgage Balance x Remaining Term in years. For example (4.79% - 2.09%) x $237,500 x 3 Years = $19,237.50
Not all mortgage programs have the same privleges and benefits. Mortgages with unusually low interest rates are attractive but they usually do not offer any flexability. These programs usually do not allow you to pay off the mortgage unless you sell your house. And, you are usually not allowed to increase your mortgage payment and/or make lump-sum payments to pay off the mortgage quicker and save money on interest charges. Therefore, getting a 0.05% or 0.10% lower interest rate, could actually cost you more in interest charges if you would like to make lump sum payments or increase your payment during the mortgage term.