Fixed vs Variable Mortgage Rates

By Urvee

If you're thinking about buying a home, chances are you'll be applying for a mortgage to fund the purchase. And when you do, you'll have to decide between fixed vs variable mortgage rates.

What are the differences between fixed and variable mortgage rates? Should you opt for one over the other? We’ll be answering both those questions and more below.

The main difference between a fixed and variable mortgage

A fixed rate mortgage has a locked in interest rate for its set term (which means the interest rate never changes). A variable rate, on the other hand, can change over the course of the term, rising or falling based on market conditions. 

Fixed rates are popular because the borrower knows the exact interest rate for the entire term. When rates are low, borrowers can save some money by locking in a fixed rate. 

A five year mortgage term is the most common, though a term can range from six months to ten years. Fixed rate mortgages are more popular among older age groups, whereas variable rates are more common for younger age groups.

Fixed mortgage rates

You've probably heard about fixed rate mortgages, but what exactly are they? 

A fixed rate mortgage is a mortgage where the interest rate doesn’t change over the term of the agreement. For example, if a five-year fixed rate mortgage has a 2.55% interest rate, that rate won’t change for the full five-year term.

Variable mortgage rates

A variable mortgage rate changes according to the prime lending rate established by the mortgage lender. For example, a variable mortgage rate will be quoted as prime plus/minus a premium/discount, such as Prime + 1.46% or Prime - 1.46%. While the premium or discount’s relationship to the prime rate remains the same over the term, the prime lending rate itself might fluctuate.

Fixed vs variable mortgage rates: pros and cons

Mortgage rate driving factors

Fixed rates are based on the Canada Bond Yields — but are always slightly higher. Bond yields are influenced by economic factors, including unemployment, inflation, and exports.

In terms of variable mortgages, the prime rate fluctuates depending on the state of the economy. Their influencing factors include unemployment, export, and inflation rate. Typically, the Bank of Canada increases the prime rate when inflation is high and decreases the prime rate when inflation is low. The former adjustment aims to make the act of borrowing money more expensive, while the latter attempts to increase the appeal of borrowing. 

The discount or premium added to the prime rate is determined by the mortgage lender depending on their competition, desired market share, and general credit market conditions — all of which also drive the difference between fixed mortgage rates and bond yields.

Canada mortgage trends

In Canada, the preferred type of mortgage is a five-year fixed rate mortgage. Fixed rate mortgages accounted for 49% of outstanding mortgages in 2020, up from 42% in 2019. 

Loan preferences change depending on the interest rate environment. For example, the increase in fixed rate mortgages’ popularity since 2019 is due to the availability of fixed rate mortgages at similar or lower rates than variable rates. When interest rates dropped in early 2020, the demand for variable rates spiked while the longer term rates were slower to adjust. Once the longer term rates began to fall into the summer, there was a high demand for five year fixed rate mortgages.

Hybrid mortgages

A hybrid mortgage combines both a fixed rate and a variable interest rate. The fixed rate is in effect for a specified period until the mortgage switches to a variable rate for the remainder of the term. The idea is to allow the borrower to benefit from a stable mortgage rate for a set amount of time, and take advantage of paying a lower interest rate for a portion of the term.

The risk involved with a hybrid mortgage is that the borrower might end up paying more if the interest rates are higher during the variable rate portion of the mortgage. While standard mortgages can be switched to another lender, hybrid mortgages cannot be switched without paying fees. It might be difficult to get approved if the borrower already carries a lot of debt.

The bottom line: fixed vs. variable mortgage rates

A fixed rate mortgage is a great option for homeowners who want to know exactly what their monthly payments will be for the next few years. This can help you stay in control of your finances and avoid any uncertainty. On the other hand, historical data has shown that with a variable interest rate you are likely to pay less than a fixed rate mortgage. That being said, trends aren’t necessarily indicative of future patterns.

In general, if interest rates are low but are about to rise, a fixed interest rate might be preferable. When interest rates are already low and not expected to fall any further, it is advised to lock a fixed rate mortgage at that rate. A variable interest rate is best when interest rates are falling as there will be the benefit of paying lower interest over time. If the fixed interest rate is significantly higher than the variable rate, it might not be worth it to pay a premium for the security of the fixed rate.