Is a variable rate mortgage right for you?

Is a variable rate mortgage right for you?

A variable rate mortgage is a type of loan that does not have a fixed interest rate. Depending on the term and conditions of your mortgage or loan, a variable rate can provide access to lower interest rates. However, there are pros and cons to consider. 

Variable vs fixed rate mortgages
What you need to know about changing variable rates 
Is a variable rate mortgage right for you?
 

Variable vs fixed rate mortgages
Generally, people seeking a mortgage choose between a fixed rate mortgage or a variable rate mortgage. A fixed rate mortgage can offer more financial stability in times of interest rate fluctuation, while a variable rate can offer access to lower interest rates. 

With a fixed rate mortgage, the interest rate is locked in for the term of the loan. This gives you the security of knowing precisely how much your payments will be, and of knowing that the interest rate won’t change for the term of the loan.  

A variable rate mortgage will have an interest rate that moves up or down in response to a benchmark, such as the prime rate. The prime rate is the annual interest rate that Canada’s major banks and financial institutions use to set interest rates for loans and lines of credit, including variable rate mortgages. Generally, with a variable rate mortgage, the monthly payment remains fixed at a specific amount, but how much of that amount goes to the principal and the interest will change as the interest rate rises or falls.

What you need to know about changing variable rates 
Many variable rate mortgage holders will have fixed monthly payments. However, if the lender increases the prime rate, one of two things may happen:  

1. The lender may increase your monthly payment to cover the additional interest. This means that you would pay more interest over the life of the loan, but the amount you are paying on the principal will stay the same. You will still pay out the full mortgage according to the original schedule.
2. The lender may allocate more of your monthly payment to the interest and less to the principal.  This means that you will pay more in interest over the life of the loan, and it will take you longer to repay the mortgage because your payments are not reducing the principal.

If your interest rate increases, your options may include:

• Make extra payments directly against the principal, so that it continues to be repaid.
• Switch to a fixed-rate mortgage, which will lock you in at the current market-fixed interest rate. 
• Pay off your mortgage balance.

Is a variable-rate mortgage right for you?
A variable rate mortgage can offer access to lower interest rates than a fixed rate mortgage. In contrast, a fixed mortgage may offer more stability and ease budgeting anxiety. However, before deciding if a variable rate is right for you, consider:

• Can you handle a potential increase in mortgage payments? 
• Can you tolerate the risks of an unstable market that may increase your mortgage payments significantly? 

To help decide if a variable rate mortgage is right for you, you can use tools such as the Financial Consumer Agency of Canada’s mortgage calculator to test different scenarios and see the impact of changes to the interest rate.