Fixed vs. Variable Mortgage Rates

Fixed vs. Variable Mortgage Rates

Perhaps the most important decision you have to make when it comes to borrowing money for a home involves whether you will sign for a variable or fixed mortgage. You have come to the best online source of information on fixed and variable interest rates in Canada. On pages such as this one, we have put together everything you need to know about the advantages and disadvantages of these rates, and you can apply for a loan quickly and easily by clicking on any of the rates on our site. Read on to understand the difference between variable and fixed rates, and choose an interest rate to apply for the product that best meets your needs.

Fixed vs. Variable Mortgage Rates: What Are the Main Differences?

When it comes to understanding the difference between fixed and variable mortgage rates, you only need to look at the ordinary meaning of the terms fixed and variable. The word fixed indicates something permanent or stable, so a fixed mortgage rate is one that never changes during the life of your loan. Since variable means “subject to change,” a variable mortgage rate is one that may change periodically during the term of your mortgage.

Deciding which of these mortgage rates is right for you depends largely on your needs and your general approach to personal finance. Those who are adverse to risk and prize stability over all other considerations will want to choose a fixed-rate mortgage. If, however, you prize saving money more than stability, a variable-rate mortgage is the better product in most cases. Consider the following list to get a better idea as to which mortgage rate is for you:

You Should Probably Get a Variable-Rate Mortgage If:

• your income can handle changes in your required mortgage payment based on changes in your variable rate
• you want to save the most money on interest payments
• fixed interest rates are not expected to decrease any time soon and variable rates are lower than fixed rates
• a drastic increase in fixed rates is likely in the near future

You Should Probably Get a Fixed-Rate Mortgage If:

• you have an income that varies greatly from month to month
• you do not like changes in your budget
• fixed-rates are predicted to increase dramatically in the near future and you are already leaning toward the fixed-rate option

How Do Banks Calculate Variable and Fixed Mortgage Rates?

Knowing where fixed and variable mortgage rates are going to be in the future is a key factor in deciding which mortgage rate is best for your needs. Of course, no one can be sure what tomorrow will bring, so it is impossible to be certain about what fixed or variable mortgage rates will be in the months and years ahead. Still, if you know how variable and fixed mortgages rates are calculated, you can get an idea of where rates are likely to go.

To understand how fixed and variable mortgage rates work, you must first understand the basics about the prime rate and the government bond market in Canada:

Prime Rate — The prime rate is the rate that major banks use to determine how much interest they should charge on short-term loans. Generally speaking, the prime interest rate does not differ widely from bank to bank because it is based on the overnight lending rate established by the Bank of Canada. This is the rate at which banks lend money to one another. The Bank of Canada strives to moderate inflation and encourage economic growth with this rate. If the economy is growing too rapidly and inflation is a real danger, the Bank of Canada will raise the overnight lending rate to discourage lending. This usually causes the economy to slow a bit and helps keep inflation in check. During times of recession or slow economic growth, the Bank of Canada often lowers the overnight rate. This makes borrowing money cheaper, which can spur the financing of home purchases, small business loans, and so on. In turn, economic decline often stabilizes and begins to change course. Since the prime rate is based on the overnight lending rate, it rises and falls in tandem with the overnight rate.

Canadian Bond Market — The Canadian government finances its operations, in part, through borrowing money from consumers and banks. Such borrowing takes the form of bonds sold to the public. These bonds provide an interest income to their holders. Bonds pay interest for a set amount of time. For example, ten-year bonds pay interest for ten years. Bond interest rates depend largely on demand for said bonds. If bonds are in high demand, rates will be higher than when they are in low demand.

Now it is time to look at how these two factors influence variable and fixed mortgage rates. Lending institutions calculate variable mortgage rates by taking the prime rate and adding or subtracting a certain number of percentage points. Instead of lending money to another bank at the prime rate, banks can lend money to homeowners at variable mortgage rates if it is in their best interest to do so. Either way, the bank earns money on what they lend.

The difference between fixed and variable mortgage rates and how they are determined is found in that banks calculate their fixed mortgage rates based on Canadian government bond yields. Banks can earn an income either by buying a Canadian government bond or lending money to a consumer. Canadian banks, to earn more money and compensate for the higher risk that comes from lending money to consumers instead of banks, will take current government bond yields and add a certain number of percentage points, passing on the new total as fixed mortgage rates.

Variable vs. Fixed Mortgage Rates: Some Interesting Facts

In this section, we have decided to present some interesting facts about fixed and variable mortgage rates:

• About two-thirds of Canadians who have a mortgage are paying fixed interest rates.
• Just under 30 percent of Canadians who have a mortgage are paying variable interest rates.
• The longer the government bond term, the higher the interest that is paid. Consequently, fixed mortgage rates will be higher as well.
• Since 2006, fixed mortgage rates have been an average of one percentage point higher than variable mortgage rates.

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