Any homeowner knows that making the jump from renting to owning is essential — everyone needs a place to call their own, one to invest in and pay towards overtime. Unlike renting, owning gives you equity and ensures a sizable return on your investment that you can borrow against or use towards another real estate investment in the future. A key consideration for affording this investment, however, is the type of mortgage that funds it.
Homebuyers are faced with various options for mortgage rates. Most commonly, aspiring homeowners are presented with fixed and variable rate mortgages, each representing different interest rate schemes. As with any loan, mortgages come with interest, but even then, there are opportunities for savings and making smart investments for your financial health. The question is though, which type of mortgage rate is best for you and your financial situation?
Fixed vs. Variable Rate Mortgage
Simply, the difference between a fixed rate and a variable rate mortgage is how they charge interest. As the names suggest, interest rates hold steady and remain the same throughout the term of a fixed-rate mortgage. A variable-rate mortgage, on the other hand, gives homeowners the flexibility — and potential savings — of fluctuating interest payments, depending on the prime lending rate.
What is a variable rate mortgage?
A variable rate mortgage is designed with the financial flexibility of homeowners in mind. Rather than lock in a steady interest rate, this type of mortgage rate rewards homeowners with potentially low-interest payments, depending on market conditions.
When the prime lending rate is low, you also make lower interest payments, essentially rewarding you with mortgage savings. Of course, if the prime lending rate were to trend upwards, you may also have to make higher interest payments. Homeowners require a steady financial cushion to absorb the impact of these fluctuations.
What is a fixed-rate mortgage?
With a fixed-rate mortgage, homeowners lock in an interest rate which holds steady for the entire term of their loan. This means predictable, uniform monthly mortgage payments that are easy to budget for.
But locked-in rates may not always be a good thing. For one, because interest rates are uniform, you may end up paying more in interest, even if market rates are on a downward trend. A fixed-rate mortgage would be beneficial if you locked in extremely low rates right before they’re poised to increase.
High Risk, High Reward vs. Predictable, but Potentially Higher Rates
Where fixed-rate mortgages tend to be uniform and predictable, a variable rate mortgage rewards homeowners with potentially lower interest payments when lending rates decline.
Lower payments mean more savings on your monthly mortgage payments; conversely, these fluctuations can result in higher interest payments if rates were to suddenly trend upwards. Similarly, while fixed-rate mortgages lock in interest rates throughout the term, homeowners may risk higher payments if rates were to decline.
For aspiring homeowners — especially first-time buyers — it’s important to understand the level of risk involved in deciding between a fixed vs variable rate mortgage in Toronto. Each type of interest rate payment impacts the long-term outlook of your mortgage: the ability to refinance and renegotiate it and save on monthly payments amidst the changing real estate market.
Historical Trends in the Housing Market
While a fixed-rate mortgage may appeal to homeowners who prefer the stability of uniform payments, a variable rate mortgage has rewarded more buyers throughout the history of the Canadian housing market. That’s because the real estate market has proven to be steady — interest rates are not volatile and are, in fact, on a downward trend.
Aspiring homeowners could save more on their mortgage payments in the long run with a variable interest rate, but it requires the safety net of extra savings needed to absorb sudden fluctuations in the prime lending rate. While most Canadian homeowners tend to be risk-averse, a smart investment in variable mortgage rates could pay off in the long run.
The Long-Term Impact of COVID-19 on the Canadian Housing Market
The COVID-19 pandemic has also presented an unexpected boom in the housing market. The Bank of Canada slashed interest rates to help keep mortgages affordable and ensure that Canadians can keep their homes in the face of economic uncertainty.
For homeowners choosing between mortgage rates, these low-interest rates are highly beneficial. The currently extremely low-interest rates are great for current variable-rate mortgages holders, as they will save on greatly reduced interest payments. Similarly, locking in these low-interest rates in a fixed-rate mortgage now could mean low-interest rates throughout the term of your mortgage.
Flexibility and Penalties
Mortgage rates also impact flexibility in refinancing and renegotiating mortgage terms. Fixed-rate mortgages do not just determine interest rates — they also impact other mortgage terms.
Fixed-rate mortgages tend to come with higher penalties for refinancing or renegotiating mortgage terms before the end of their duration. This can quickly become expensive if you need to break your mortgage to move, refinance to withdraw equity, or want to switch to a lower rate.
In contrast, a variable rate mortgage provides more flexibility and a lower risk of penalties. A variable rate mortgage typically only charges 3 months’ worth of interest penalty if you need to break and restructure your mortgage — a much smaller price to pay, especially with low-interest rates.
Fixed vs. Variable Rate Mortgage: What’s Best for You?
Choosing between a fixed and variable rate mortgage depends on your specific financial situation.
For savvy and experienced buyers who are comfortable dabbling with the market, a variable rate mortgage can be highly rewarding and cost-saving — provided that you have enough resources to absorb sudden fluctuations in the interest rate. In contrast, a fixed-rate mortgage allows homeowners to lock in a good rate and budget.
Choosing between the two then is a matter of what best suits your future financial outlook, which an experienced mortgage broker can help you determine.
To learn more about how to choose between a fixed vs variable rate mortgage in Toronto, call My Phoenix Group at 833-551-0266, or contact us here.