Fixed Rate vs. Variable Rate
The decision to choose a fixed or variable rate is not always an easy one. It should depend on your tolerance for risk as well as your ability to withstand increases in mortgage payments.
Fixed rate mortgages often appeal to clients who want stability in their payments, manage a tight monthly budget, or are generally more conservative. For example, young couples with large mortgages relative to their income might be better off opting for the peace of mind that a fixed-rate brings.
A variable rate mortgage often allows the borrower to take advantage of lower rates – the interest rate is calculated on an ongoing basis at a lenders’ prime rate minus or plus a set percentage. For example, if the current prime mortgage rate is 3 percent, the holder of a prime minus 0.5 percent mortgage would pay a 2.50 percent variable interest rate. Historically, variable rate mortgages have consistently outpaced fixed rate mortgages with regards to interest savings.
As a consumer, the best option is to do as much research as you can followed by a candid discussion with your mortgage professional to ensure you have a full understanding of the risks and rewards of each type of mortgage.
Variable Rate Mortgage:
A mortgage whose interest rate is adjusted periodically to reflect market conditions. Variable rate mortgage products appeal to some people because the rate is calculated based on prime rate and is typically lower than the fixed rate. Payments are generally fixed over a period of time (ex. Five years). As interest rates go down more of the mortgage payment goes to principal. But as interest rates go up less goes to principal. This means that your amortization period (the number of years you’ve selected to repay the mortgage (both principal and interest) could be longer or shorter if interest rates have risen or fallen since the start of the term.
Open Variable Rate:
Open variable-rate mortgages allow you to put down as much as you want, or pay off the entire mortgage at any time. It also lets you change to another term at any time, without charge. Payments are generally fixed throughout the term. This product is ideal for those who have swings in their cash-flow that would allow them to pay their mortgage off in lump sums, are thinking of selling their home, wish to prepay more than 20 per cent of their mortgage amount or believe rates will decline. However, expect higher rates with an open variable-rate mortgage product than a closed rate mortgage product of the same term length.
Closed Variable Rate:
With closed variable-rate mortgage products, the payments are generally fixed for the term. It’s important to know what your prepayment options are. Can you make lump-sum payments? How much and how often? Typically closed variable rate mortgages will have limited prepayment options.
Fixed Rate Mortgage:
The interest rate is set for a specified term with a fixed payment that does not fluctuate unless the borrower manually increases their payments. The appeal of a fixed rate mortgage is that they allow you to accurately budget. You know what your mortgage payment will be for a determined length of time, as well as how and when your mortgage will be paid in full.
Open Fixed Rate:
Like all fixed rate mortgages, your mortgage payment will not change throughout the term. You’re able to prepay in full or in part at any time with no prepayment charge as well as change to another term at any time without charge. Ideal for those who want maximum flexibility, are thinking of selling their home. Also useful when you want to prepay more than 20 per cent of the mortgage amount or believe rates will decline in the near future and wish to wait before locking into a lower fixed rate. Also note that open mortgage rates are slightly higher than Closed mortgage rates.
Closed Fixed Rate:
Your interest rate and payments are fixed for the term you choose. This type of mortgage product is the most common among first time home buyers and ideal for the budget-conscious who prefer peace of mind, knowing rates will not rise during the selected term. They also want a lower rate than an open mortgage of the same term.
Convertible Fixed Rate:
Provides the option to convert to a closed term of one year or longer at any time, without charge. This product may be for you if you want to keep your options open and want a lower rate than an open mortgage of the same term. Your prepayment privileges are less flexible than those of an open mortgage as a side effect of the benefits.