There are two common mortgages in Canada.
- Fixed-Rate Mortgage
- Variable-Rate Mortgage
A fixed-rate mortgage is simple. A bank quotes you an annual percentage rate and term. As an example, you are quoted 2.5% for 5 years on a $500,000 loan, amortized over 25 years. You agree to pay the $500,000 (+ interest and other expenses) back to the bank in equal monthly payments.
Amortization is simply the process of spreading out a large loan into a series of smaller fixed payments over a set period of time.
Variable Rate Mortgages
Variable rates are different. They have a fixed term just like fixed-rate mortgages but the rate can change regularly (sometimes as often as every month). Any movement in the government set rate can affect the variable mortgage rate. As an example you are quoted 2.35% for 5 years on a $500,000 loan, amortized over 25 years. This 2.35% is lower than the 2.5% fixed rate so you can pay more dollars to the principal of the loan (and thus pay it down faster) however there is an inherent risk here as the variable-rate can also change to 2.65% which is higher than the fixed-rate and thus you are paying higher interest and less of the principal. Alternatively, the variable-rate can change to 2.15% which is lower and you can then pay even more to the principal and pay your mortgage down faster.
You can structure a variable rate mortgage in two different ways; either with a fixed payment amount or with fluctuating payments. If you choose fixed payments, the amount allocated to the principal or interest is dependant on the variable interest rate. If you choose a fluctuating payment your mortgage payment can change from month to month.
What Should You Do?
It really depends on you… If you have a need for financial consistency you may find it easier with a fixed-rate mortgage, but those who can handle a little more uncertainty might find variable-rate mortgages more desirable.
Many studies have shown that those who accept variable-rate mortgages generally save money in the long term but this is not a guarantee. There are many other factors to consider when deciding on a mortgage plan, such as penalty clauses, balloon payment options, portability, and much more.
Pro-Tip: The banks won’t tell you this but a variable rate mortgage carries a lesser penalty than the fixed-rate. We are not talking a couple of bucks here, we are talking a difference of potentially ten thousand dollars (or sometimes even more).
Selecting the best rate and mortgage can be tough and whether you are saving for an amazing vacation, your perfect dream home, or the best lifestyle for your family the best mortgage advice will come from a mortgage broker.
If you need a partner that can guide you through this process, please give me a call anytime at 604-202-9913. I am happy to work together with you and find the best mortgage solution for you.