fixed rate mortgage or variable rate mortgage

Fixed Rate Mortgage or Variable Rate Mortgage

By mortgageassociatesontario
In June 28, 2018

Fixed Rate Mortgage or Variable Rate Mortgage?

A common question that comes up amongst home owners and home buyers, when deciding on the type of mortgage they should take, is whether to get a fixed rate mortgage or a variable rate mortgage. Below is a summary of the pros and cons of getting a fixed rate mortgage and a variable rate mortgage.

Fixed Rate Mortgage Definition

fixed rateA fixed rate mortgage is a mortgage interest rate which doesn’t change during the term of the mortgage. With a fixed rate, the interest rate, and monthly payments remain the same during the entire term of the mortgage (not amortization period).

Fixed Rate Mortgage Advantages

The advantage of a fixed rate mortgage is that your monthly payment and interest amount stays the same for the entire duration of the term of the mortgage. Regardless of the fluctuation of interest rates in the market, the monthly payments and interest amount will never change during the term. A fixed rate mortgage creates a sense of security for a home owner.

Fixed Rate Mortgage Disadvantages

There are two significant disadvantages of a fixed rate mortgage:

  • The interest rate is usually higher than the variable rate mortgage
  • The penalty for early repayment of a fixed rate mortgage can sometimes be much higher than the variable rate mortgage

Fixed Mortgage Penalty

The penalty for breaking a fixed rate, in most cases, is the greater of three months interest payments or interest rate differential. The penalty for exiting a fixed rate mortgage early is calculated at the time a home owner decides they want to break their mortgage, and is calculated based on the number of months remaining in mortgage term (not amortization period)

Variable Rate Mortgage Definition

variable rateA variable rate mortgage is a mortgage with an interest rate that can fluctuate up or down, and is attached to the prime rate. The prime rate is set by the Bank of Canada, and every lender usually follows suit, and adjusts their prime rate to match the Bank of Canada’s prime rate.

Variable Mortgage Advantages

The advantage of a variable rate mortgage is the monthly payment and interest rate is usually much lower than the fixed rate mortgage, however can increase during the term of the mortgage.  A variable rate, unlike a fixed rate, can be converted into a fixed rate, with most lenders, during the mortgage term, whereas a fixed rate cannot be converted to a variable rate. One significant advantage to a variable mortgage is the penalty for breaking a variable rate mortgage; which is usually only three months interest payments, at any time during the term of the mortgage.

Variable Mortgage Disadvantages

The main disadvantage of a variable rate mortgage is the interest rate is attached to the prime rate, which can go up or down at anytime during the term of the loan, and consequently the variable rate will go up or down. This can create a sense of insecurity for some home owners.

Variable Rate Mortgage Penalty

The penalty for breaking a variable rate mortgage, with most variable rate mortgage products, is three months interest payment only. The reason for why we say with most variable rate mortgages, is that there are some lenders offering a much lower variable rate than the market rate, such as RMG Mortgage’s Low Rate Basic Variable Rate, which comes with a 3% penalty for existing a variable rate mortgage, in exchange for the much lower rate. This specific product is designed for home owners who are certain they will keep their mortgage for entire duration of the term of the mortgage, as the penalty for breaking a low rate basic mortgage is significantly high.

Fixed Rate Mortgage or Variable Rate Mortgage?

In conclusion, both fixed rate mortgages and variable rate mortgages have their pros and cons. Depending on what the actual interest rate is for both mortgage types, a home owner should decide carefully which type of mortgage to obtain. This can be dictated by the home owner’s household income, future plans with their property and mortgage, and comfort level with either mortgage type.

In instances where the variable rate is significantly lower than the fixed rate, we tend to recommend a home owner takes advantage of the variable rate, while it remains much lower than the fixed rate, as they have an opportunity to save potentially thousands of dollars in interest, and pay down their mortgage principal balance much faster. We also recommend this as the variable rate can be converted into a fixed rate, with most lenders, during the term of the mortgage, whereas the fixed rate cannot be.

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