Choosing the right mortgage: Fixed rate or variable rate?
Whether you're already a homeowner or you're getting ready to buy your first home, a lot of questions can come up when it's time to choose a mortgage. Your choice will depend a lot on what's most important for you, especially in times of economic uncertainty: paying off your loan as quickly as possible or maintaining maximum flexibility. Here's what you need to know to make an informed choice.
Contrary to popular belief, your payment amounts will usually be fixed, whether you choose a fixed or variable rate. Here are some of the key features of each rate type.
A fixed interest rate remains the same for the entire term. The portion of each payment allocated to the principal and interest will remain the same, meaning you'll know what your loan balance will be at renewal. The payment amount remains the same unless you decide to increase it.
This means you'll avoid potential surprises related to interest rate fluctuations. But this stability and peace of mind come at a price. The fixed rate is generally higher than the variable rate available at the same time. However, the variable rate could be higher in some economic environments.
Finally, if you want to end your contract early (for example, because you're selling your property), you may have to pay a penalty. The penalty amount is generally higher with a fixed rate than with a variable rate.
The variable interest rate is based on the lender's prime rate. With a variable rate, the portion of each payment that's used to pay down your principal will depend on the prevailing interest rate. Generally speaking, the payment amount will remain the same unless you decide to increase it. However, if there are several consecutive increases in the variable rate and your payment is no longer sufficient to cover the interest portion of the loan, it may be a good idea to increase your payment amount so you can keep paying down your mortgage.
If you can tolerate some fluctuation, you'll save money with a variable rate, provided the variable rate stays below the fixed rate that was in effect when you signed the contract.
Good to know
In addition to the type of interest rate, several other factors can influence your payments: the frequency of payments, the term of your loan and the amortization period. Learn the basics so you can choose the mortgage that's right for you.