Fixed vs. Variable Mortgage
Capped Variable rate?
Are you feeling overwhelmed with all the different types of mortgages available to you? You definitely aren’t alone! We are the experts who live, eat, and breathe mortgages and at times the number of options can sometimes seem daunting to us as well. As your mortgage planners, we can help you trek through the jungle of options available to you to determine exactly what sort of mortgage will best suit your particular needs. Whether it be a fixed vs variable rate, closed vs open, or any combination of them. Just like snowflakes, no 2 people’s needs in their mortgages are exactly the same, so you should definitely consult a licensed mortgage broker to help you make sure you have the best mortgage plan for you.
Today’s mortgage world is no longer as simple as just deciding between a fixed rate vs variable rate mortgage. There may be a huge number of factors contributing to your mortgage rate and also to which mortgage works best for you.
Generally speaking, when deciding between a variable rate mortgage or a fixed rate mortgage, you need to determine:
- Can you afford fluctuations in the interest rate – ie can you weather the fixed vs variable rate storm?
- How much do you think interest rates will go up or down during the term?
Typically our recommendation would be that if you’re considering the variable vs fixed, a prudent mortgage plan when taking a variable rate would be to increase your payments on the variable rate mortgage to at least match what you would have been paying on the fixed rate mortgage. This strategy allows you to minimize the risk and pay off your mortgage quicker when rates are still low.
If you are struggling with the decision or just feel like you’re drowning in options, we urge you to contact us to create a mortgage plan for you and go through the numbers with you. We can run different scenarios to help you make your decision an easier one to make.
For a quick run down of the pros and cons of fixed vs variable rate mortgages, see below:
|Variable Rate Mortgages|
|lower interest rate||higher risk|
|Fixed Rate Mortgages|
|lower risk||higher interest rate|
|no fluctuations||higher penalties|
To help educate you with your decision and navigate the murky mortgage waters, below is a quick summary of the different common types of mortgages you may run into.
A CLOSED MORTGAGE is a mortgage where, should you choose to pay the mortgage out during your term, you would be subject to a penalty. This is the most common type of mortgage. A closed mortgage is offered at a significantly lower interest rate than you would see on an open mortgage given that the bank has more certainty about how long you will have the mortgage for. Many banks and lenders have different calculations for calculating the penalty, you can find more detail on penalties on your specific lender’s website or contact us for further explanation. Often closed mortgages will allow you to pay off a portion (typically 10-20% of the mortgage amount) without penalty each year by making additional payments to the principal.
An OPEN MORTGAGE is a mortgage where you can prepay any portion or all of the mortgage at any time without penalty. Given the uncertain amount of return the banks will get, they will charge you a higher interest rate on an open mortgage than on a closed mortgage. Depending on the amount of time you plan to have your mortgage, there may be some savings with not having a penalty to pay it out.
A FIXED RATE MORTGAGE is a mortgage where your interest rate is guaranteed for the entire term of your mortgage. This mortgage may be for anywhere from a 1-year to a 10-year term. The distinct benefit of the fixed rate mortgage is that it comes with the safety of always knowing your interest rate for your mortgage term without any upside risk until it comes up for renewal. The downside is that the security comes at a cost. Generally speaking, they will be at higher interest rates, which typically increase as you increase the length of term you want it to be secured for – so often you will see a much lower interest rate for a 1-year term than you might for a 5-year or 10-year term. Fixed rate mortgages may be open or closed, with open mortgages coming at a significantly higher interest rate. Penalties on fixed-rate mortgages are determined by a formula of the greater of the interest rate differential penalty or three months of interest.
A VARIABLE RATE MORTGAGE (VRM) is a mortgage where your interest rate will fluctuate during the term of your mortgage at a rate that is above or below the prime lending rate depending on a number of factors. A closed variable rate mortgage will often come with the lowest interest rate available, but has the least amount of security as you are subject to increases or decreases in the prime lending rate. In a variable rate mortgage, your payment will never change even as the interest rates change. As interest rates go up, less of your payment will go towards the principal and more towards the interest but your payment is fixed. If the rate goes too high to not allow for repayment of the mortgage, your payment will increase to ensure your payment is high enough. As rates decrease, more goes towards the principal and less towards the interest. Most lenders will allow you to lock a VRM into a fixed rate at any time without penalty, subject to the fact that you are locking in to whatever the fixed rates are at that time (so they may be even higher then as well). VRM’s can be open or closed mortgages as well, but the open rate will often come at a rate 1.5%-2% higher. The penalty on a closed VRM will always be 3 months of interest.
An ADJUSTABLE RATE MORTGAGE (ARM) is almost the exact same as the VRM above, with the one main difference that as interest rates change your payment will change to keep your amortization the same. What this means is that you will always keep paying off your mortgage at the same pace, regardless of changes in interest rate.
A CAPPED VARIABLE RATE MORTGAGE is a VRM mortgage as described above where your interest rate will change as described in the situations above, but will not go above a pre-described interest rate. The interest rates on these types of mortgages are often much higher than on a standard VRM or ARM, so while they have less risk, they also have less reward. These rates may be 0.5%-1% higher than a standard closed VRM or ARM.
A HELOC, or Home Equity Line of Credit, is a re-advanceable mortgage product secured to your home. These are available on properties up to 65% of the appraised value of the home and in order to go to 80% of the value they may be combined with a mortgage product as described above. A HELOC is fully open for repayment at any time, and the funds paid off may be re-accessed again. There are additionally All-in-one mortgage and HELOC products available where a mortgage is taken for a larger portion and as the mortgage is paid off, the limit on the line of credit automatically increases by the same amount. These can be great products for people interested in future investing or purchasing an older home that may require renovations in the not too distant future.