Basics Series: Fixed vs Variable

Selecting your mortgage term is an important decision you need to make when applying for a mortgage, that will determine your monthly payments. There are many significant differences are between a fixed rate term and a variable rate term other than just the interest rate.

A fixed-rate mortgage has an interest rate that remains the same for the entire term of the loan, typically 25 or 30 years. A variable-rate mortgage, also known as an adjustable-rate mortgage (ARM), has an interest rate that can change over time, typically in response to changes in a benchmark interest rate such as the prime rate. This means that with a variable-rate mortgage, your monthly payments can increase or decrease over time.

Fixed-rate mortgages offer predictability and stability, as the borrower knows what their monthly payment will be for the entire term of the loan. This can make budgeting and planning easier. Variable-rate mortgages, on the other hand, can be riskier for borrowers, as the interest rate and monthly payments can change unexpectedly. However, they typically have lower initial interest rates, which can make them more affordable for some borrowers. (There are different types of Variable -ARM terms, but we will cover that in a separate post).

One of the most important features to consider before deciding on your mortgage term, is the prepayment penalties of each option. In Canada, six out of every ten mortgages contracts are paid out or rewritten before maturity and the penalty charges seriously impacts what your true cost of borrowing actually is. You can pay dearly for not checking into this as every bank calculates and applies these penalties differently. Unfortunately, many people don't consider this risk when they sign up for a new mortgage term.

It's important to weigh the pros and cons of both types of mortgage options and consider your personal financial situation and risk tolerance before making a decision. It's also wise to consult with a financial advisor or mortgage broker to get more information and help you make the best decision for your situation.

Don't be shy about asking questions and make sure you fully understand the features, benefits, pros and cons of your options before siging the contract for your next mortgage term. Every financial institution has their own rules, methods, and procedures, so don't assume; always ask and confirm!