When it comes to mortgages, one of the most important conversations I have to have with my clients is whether to choose between a variable or a fixed interest rate. It raises the common question – which is better? Each has their own advantages and disadvantages. Do you choose a bit of risk when it comes to payments or more stability? My goal here is to educate you on your options for you to make an informed decision.
Variable Interest Rate Mortgage:
Choosing a variable rate mortgage is most dependent on your lifestyle, spending habits, income and risk tolerance. Will your budget be able to manage an increase in payments if interest rates are to rise? If so – you will be rewarded with the ability to save money over the amortization of your mortgage. A variable rate mortgage (VRM) usually has a lower interest rate compared to that of a fixed rate mortgage and this is what gives you the ability to save money relative to a fixed rate mortgage. The risk involved is when the Bank of Canada raises their lending rates causing mortgage lenders to raise their lending rates and thus, the allocation of each payment (between principle and interest) will change.
There are a few ways to mitigate the risk of a variable rate mortgage. Although you can’t control an increase in interest rates, you can certainly prepare yourself for them. Variable rate mortgages give you the ability to switch into a fixed rate mortgage at no cost to yourself. If you feel as if there will be an increase in interest rates, we can make the switch to a fixed rate for the remaining term of your mortgage.
Another way to mitigate risk is by choosing to have your mortgage payment higher than the minimum payment set out by your lender – because your interest rate is lower in a variable rate mortgage, your payments will be lower as well. This allows you to create a buffer zone in case mortgage rates are to rise. In other words, you’d be ahead in payments towards the outstanding balance of your mortgage and because of that, your amortization period would be shorter. TIP – look into accelerated payment options to decrease the amortization period of your mortgage.
Fixed Interest Rate Mortgage:
The biggest benefit of having a fixed rate mortgage is that you know what your exact payment will be for the term of your mortgage – assuming you don’t refinance or take out some of that hard earned equity. It is the most popular choice of mortgage types as it is more for the risk-free individuals. It gives you the confidence of not having to factor in for future fluctuations when it comes to budgeting your money.
Although there is no need to mitigate risk with regards to a fixed rate mortgage – there are still ways to get ahead and reduce the amortization. As mentioned earlier these come in the form of increased payments, lump sum payments or accelerated payments.
Penalties:
If, for some reason, you need to break your mortgage before the term is up (maybe because of an equity take out or debt consolidation), the lender will charge you a penalty to do so. They come in the forms of either a 3 month interest rate penalty or an interest rate differential penalty. With a Variable Rate Mortgage, the penalty will be a 3 month interest rate penalty. The penalties get a bit complicated when it comes to a Fixed Rate Mortgage – the lender will choose between a 3 month interest rate penalty and an interest rate differential penalty, whichever is the GREATER amount. An interest rate differential penalty often results in astronomical penalties (anywhere from 2x to 9x larger than a 3 month interest rate penalty) being charged on fixed rate mortgages, depending on the lender.
As a mortgage agent, I am stressing that you – as a buyer – are aware of your options and the specifics of your mortgage before you sign the dotted line. Although you may like the idea of being able to save money over the length of your mortgage, you may have more peace of mind knowing your mortgage payments will be consistent throughout the term of your mortgage.