Fixed Rate vs. Variable Rate
The decision to choose a fixed or variable rate is not always an easy one. It should depend on your tolerance for risk as well as your ability to withstand increases in mortgage payments.
YOU CAN SOMETIMES EXPECT A FINANCIAL REWARD FOR GOING WITH THE VARIABLE RATE, ALTHOUGH THE PRECISE MAGNITUDE WILL EBB AND FLOW DEPENDING ON THE ECONOMIC ENVIRONMENT.
There are two types of variable rates available in Canada.
1. VRM – Variable Rate Mortgage – This type of variable-rate mortgage offers static payments. This means that when the prime rate increases or decreases the mortgage payment will remain the same and the principal and interest portions of the payment will adjust. Higher rates mean less principle and more interest and on the other side, lower interest rates mean a higher principle and lower interest portion. This also will affect the remaining amortization. A higher interest rate will increase the amortization and a lower interest rate will mean a lower amortization. These types of mortgages also have a built-in provision called a trigger rate. If the rate gets too high as it did this year (2023), the lender will automatically increase the payments to account for all of the extra interest and also in some cases to put the mortgage back on track for the original amortization.
2. ARM – Adjustable Rate Mortgage – This time of variable-rate mortgage offers adjustable payments. As the prime rate increases and decreases, the lender will automatically increase or decrease the mortgage payment to match the original mortgage amortization.
Fixed-rate mortgages often appeal to clients who want stability in their payments, manage a tight monthly budget, or are generally more conservative. For example, young couples with large mortgages relative to their income might be better off opting for the peace of mind that a fixed rate brings.
A variable rate mortgage often allows the borrower to take advantage of lower rates – the interest rate is calculated continuously at a lender’s prime rate minus or plus a set percentage. For example, if the current prime mortgage rate is 7.20 percent, the holder of a prime minus 1.05% percent mortgage would pay a 6.15% variable interest rate.
Variables come with many strategies. One, you will almost always have a 3-month interest penalty to break the mortgage early. Another approach would be to take the variable rate of interest and save money and interest savings to increase your mortgage payment and pay the mortgage down faster. This strategy alone can save $1000s of dollars in interest and pay down your mortgage faster.
History has shown that variable mortgage rate shoppers do better long-term than fixed-rate mortgage holders.
The most important question that you need to answer as a borrower is “Is a variable-rate mortgage suitable for you?”.
As a consumer, the best option is to have a candid discussion with your mortgage professional to ensure you have a full understanding of the risks and rewards of each type of mortgage.
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