22 Jul

Considerations for finding the best mortgage rate: fixed vs. variable

General

Posted by: Maria Solverson

This blog is adapted from an original article by Moneysense. It’s well worth the read!

After consecutive years of record-low interest rates in Canada, we are entering a period of rising rates—which makes the cost of borrowing money, be it for a mortgage or a student loan, more expensive. The possibility of more rate hikes can make the stability of a five-year fixed mortgage rate seem like a good option compared to one with a variable rate—especially for first-time homebuyers or those about to renew their existing mortgage. In fact, five-year fixed-rate mortgages are the most popular mortgage product in Canada. However, as with any financial product, they still have their drawbacks.

Learn more about how they compare to five-year variable mortgage rates.

What is a five-year fixed mortgage rate? 

As the name implies, a five-year fixed-rate mortgage comes with a mortgage term of five years—that’s the duration for which your mortgage contract remains in effect. In Canada, mortgage terms range from six months to 10 years, with five years being the most common.

With a fixed-rate mortgage, your mortgage interest rate is locked in for the period of the contract. This means you can predict what your mortgage payments will be until your mortgage contract comes to an end and it’s time to renew.

For this reason, fixed-rate mortgages can provide a greater sense of security than variable-rate mortgages. With a variable-rate mortgage, the interest rate can fluctuate throughout the term. This flux occurs as lenders adjust their prime rates in response to changes to the Bank of Canada’s overnight rate. The prime rate is at 4.70% at the time of this publishing.

Finally, fixed-rate mortgages can be open or closed. Whereas an open mortgage comes with the option of making additional regular or lump-sum mortgage payments without penalty, these actions are financially penalized with a closed mortgage. As a rule of thumb, closed-term mortgages come with lower interest rates because they offer less flexibility than open mortgages.

How to compare five-year fixed mortgage rates

If you are shopping for a mortgage on a new home purchase, use an online calculator to input your property and payment details and view the best fixed mortgage rates available. The tool can also be used to view mortgage rates for products with different rate types, such as variable.

The mortgage rates comparison calculator offered by MoneySense works really well.

Using this calculator, you can view mortgage rates for the following:

Mortgage renewal: If your mortgage term is coming to an end and you have an outstanding mortgage balance, you will have to renew your contract for another term. You can do this with either your existing lender or another one—but it’s always good to shop around! To view mortgage renewal rates for a new five-year term, use the MoneySense calculator linked above to enter your current mortgage balance, remaining amortization, mortgage payment frequency and location.

Mortgage refinance: If you want to break your current mortgage contract and negotiate a new contract, that’s called refinancing. You may want to do this to take advantage of lower interest rates or access equity in your home. However, the decision to refinance should not be taken lightly, because you could end up paying significant penalty fees. If you want to see five-year mortgage rates on a mortgage refinance, enter your current mortgage balance, as well as the amount of equity you wish to access.

Home equity line of credit (HELOC): This is a revolving line of credit, for a pre-approved amount of money, that allows you to borrow from the equity in your home. The interest rates on HELOCs are usually lower than those for traditional lines of credit, but higher than those typically offered for variable-rate mortgages. The money borrowed through a HELOC is repaid, with interest, in addition to your regular mortgage payments.

How are five-year fixed mortgage rates determined in Canada? 

Rates for five-year fixed mortgages are strongly linked to the price of five-year government bonds. Banks rely on bonds to generate stable profits and offset potential losses from the money they lend as mortgages. When banks expect their bond profits to increase, they lower their fixed-mortgage rates, and vice versa.

Historically, fixed rates have tended to hover above variable rates, however there are a few instances when variable rates have surpassed fixed rates. This historical trend suggests buyers may end up paying more for fixed mortgages, especially during periods of falling interest rates.

However, when Canadian inflation rates exceed the norm, hikes in the Bank of Canada’s overnight rate—which lead to higher variable interest rates—are often not far behind. At times like these, locking in a fixed mortgage rate could be a smart option for borrowers who want to avoid the fluctuations that come with variable-rate mortgages.

The pros and cons of five-year fixed rate mortgages

Pros: 

  • Competitive rates: Lenders know you are shopping around, and they will generally offer comparable and lower rates for your business.
  • Predictability: You know your interest rate, and therefore your mortgage payments will not change for the duration of the term. That stability can help you budget more easily.
  • Potential to save money: If interest rates increase during your term, you could end up paying less than you would with a variable rate.

Cons: 

  • Stiffer penalties: The penalty to get out of a fixed mortgage contract can be quite a bit higher than with a variable mortgage. You may also be more limited in your ability to pay off your mortgage faster through additional payments.
  • Potential to pay more in interest: Historically, fixed rates have been priced higher than variable rates, with a few exceptions. In some instances, you could end up paying significantly more in interest than you would with a variable rate, if market interest rates fall during your term.
  • Higher cost: You will pay for predictability and peace of mind. When comparing fixed to variable rates, you will see that fixed can be slightly higher.

Is a fixed-rate mortgage better? 

My approach is that it always comes down to your finances, intentions for the property, and risk tolerance.

Ideally, if you are choosing a variable rate, you would have finances available to cover sudden rate hikes. If you have savings set aside that can help you ride the cyclical wave of rising and dipping variable rates (and you can sleep easy at night knowing that your rate will fluctuate) variable could be right for you.

Additionally, if you intend to own your property for a short time, a variable mortgage could be the better option because these mortgage contracts are easier to break out of early. They tend to come with lower penalties than fixed rate mortgages.

There is no single solution that will work for everyone. Every situation is unique, which is why it is so important to talk to a mortgage broker about your finances, plans for the future, and risk tolerance. I am here to help you determine what course of action is best for you!

What happens when my mortgage term ends? 

When your mortgage term ends, your mortgage contract will be up for renewal. A few months before it ends, your lender will send you a renewal statement that will include details on the remaining balance on your mortgage, your new interest rate at renewal, your payment schedule and any fees that may apply. At this time, you can choose to renew your mortgage with your original lender or comparison shop for a better rate from another lender.

No matter which lender you decide to go with, it’s always worth reviewing what five-year fixed mortgage rates are currently being offered in Canada before deciding to renew or switch products or lenders.

I recommend putting your renewal date in your calendar along with a reminder to contact your mortgage breaker at least six months in advance of this date. By doing so, you give yourself and your broker ample time to shop around on your behalf and secure the best rate and terms available to you. It might feel easiest to simply renew with your current lender, but there could be a better deal out there and you deserve the chance to compare your options at this stage, just as you did when you first bought.

Should you choose a five-year fixed mortgage rate?  

When deciding if a fixed-rate mortgage is right for you, there are a number of key factors to consider, including the historical performance of five-year fixed mortgage rates. Depending on what happens with market interest rates during your term, you may pay extra, but those additional costs could save you from the stress of predicting ups and downs in the economy and interest rates.

If you are not sure which option suits you best, give me a call! I am here to talk, and my advice is always free.

This blog is adapted from an excellent original article by Moneysense.