What to know about interest rates and your variable mortgage
Take a look at any promotion for a mortgage and one thing will consistently get thrown at you: interest rates. You may have a general idea of how mortgages work and that a lower interest rate is what to shoot for, but mortgages come in several flavours, including fixed and variable rates. Here’s what you need to know about variable rate mortgages.
The terms “fixed” and “variable” refer to the interest rate on a mortgage. Like any other loan, a mortgage accrues interest. Interest on a fixed rate mortgage is just that: fixed. Once you lock in your rate it won’t change. This makes it very easy to budget for your mortgage payments because they won’t fluctuate. A variable rate mortgage changes over time, and that means your payments can change as well.
What is a variable rate mortgage?
Variable rates are typically the lowest mortgage rates available, but they come with a caveat. They may not be the lowest a few years from now. Variable mortgage rates can change during the mortgage term.
How a variable rate can save you money
This concept is pretty simple. If you have a lower interest rate, you pay less interest. That means if rates stay stable or get lower during your mortgage term, you pay less interest than someone who has a fixed rate.
Conversely, if you have a variable mortgage and rates get higher, this normally causes monthly mortgage payments to move higher along with them, although some lenders or products may allow for the payment to be fixed but a bigger chunk of it will go towards interest first before paying off the principal. Either way you’re paying more than you were before.
Understand the prime rate
To understand how mortgage rates change, it’s important to know how rates are impacted by the Bank of Canada’s prime rate. According to Young and Thrifty:
“The Bank of Canada uses the prime rate to adjust for inflation. When there isn’t very much inflation, the prime rate will remain low. When inflation skyrockets, the prime rate will increase because the Bank of Canada needs to adjust for this.”
Most recently the prime rate has been at a historical low, causing mortgage rates to follow suit. The relationship between the prime rate and the mortgage market’s rates isn’t exactly direct, but you can be sure that when the prime rate increases so will the market rates, and when the BoC cuts the rate, you will find that mortgages cost less.
So, fixed or variable?
Home buyers have been asking this question for a really long time. The answer depends on when you’re asking. Right now, heading into the end of 2016, it looks like rates are going to be pretty stable for the next year or two. A few years down the road, though, there’s a strong possibility rates could slowly start to rise. It’s a total guessing game as to what the rate changes would amount to. There is a small chance that grabbing a variable rate mortgage could still lead to a comparatively lower amount of interest owed. The Bank of Canada is well aware of how indebted Canadians are and that raising rates will put some homeowners under increased strain to afford their mortgage.
That means locking in a low fixed rate now is most likely the best option for now, but that doesn’t mean it will be forever. Historically, variable mortgages perform better over time. Keep variable rate mortgages in mind should things change in the future.