If you’ve received your mortgage renewal agreement and your mortgage is up for renewal soon, you may be wondering whether you should lock into a fixed rate or choose a variable rate mortgage this time around.
Historically, the variable rate mortgage has always been cheaper over the long run despite the economy going through periods of volatility and rates increasing and decreasing. Overall, however, the savings achieved through having a variable rate have always been greater than the savings offered through fixed-rate mortgages.
Nevertheless, each person’s situation is different, and while one person may be able to withstand times of higher interest rates, another person may not. Therefore, choosing a variable rate mortgage requires careful consideration.
A variable rate is usually set at either Prime Rate, Prime Rate Plus an Interest Rate (Prime Rate plus a premium) or Prime Rate less an Interest Rate (Prime less a discount).
Prime Rate itself is influenced by the Bank of Canada’s overnight lending rate, which is further determined by economic conditions and the Government’s attempt to maintain healthy inflation. In November 2000, the Bank of Canada introduced a system of eight fixed dates each year on which it would announce whether or not it would change the policy interest rate, otherwise known as the overnight lending rate.
Therefore, it’s important to realize there’s an opportunity for the Prime Rate to fluctuate up to eight times a year, and if you are someone who cannot afford interest spikes, the variable rate may not be for you.
A fixed-rate on the other hand simply means the rate will stay the same for your entire mortgage term. So for example, if you choose a five-year closed mortgage, this will mean your payments will be determined by the same rate for five years, and there will not be any fluctuation to your payment.
Fixed-rate mortgages are obviously beneficial because someone can budget their payments each month and not have to deal with the stress of following the market or the Bank of Canada’s overnight lending rate meetings.
On the flip side, however, a person who chooses a fixed rate will miss out on an opportunity to pay a lower interest rate and may be faced with a large penalty should they decide to exit their mortgage early.
There will always be a penalty to exit a closed mortgage before the contract expires, which is why it’s important to consider how penalties get calculated for both fixed and variable rate mortgages.
A variable rate mortgage will always be just three-months of interest - it doesn’t matter where you are in the term, the calculation will be the same.
Fixed-rate mortgages are calculated differently and often, more punitively. A fixed-rate mortgage is calculated using an Interest-Rate-Differential (IRD) formula. The penalty is either three months’ worth of interest OR the IRD, whichever is greater.
For more information, please do not hesitate to call or write.
Sarah A. Colucci
Mortgage Agent Lic. M14000929
Mortgage Edge, Broker 10680
Direct: (647) 773-4849
By: Sarah Colucci