The debate on which one is better fixed vs variable mortgage has been going on for a long time now. According to the statistics, people tend to choose fixed mortgages (approximately 65% of respondents). There are also variable (~28%) and combined (~7%) types of mortgages that are chosen less.
Today we are going to talk about these types, their pros, and cons and give you an approximate example of how much you can pay for each type, based on the comparison of a 5-year mortgage (do not forget that there are other options like 10 or 30-year mortgages).
Prime Rate in Canada
First of all, let’s talk about the prime rate. This rate is currently at 2.45%. It plays a very important role in determining what type of mortgage you should choose. Historically, the Bank of Canada was at its peak in 1981 with a prime rate of more than 22%! But now it has stabilized a bit.
The prime rate is the interest rate that banks use when they loan money to their clients. It’s usually higher than the average interest rate of other types of loans. It is formed according to the economical state of the country. The bank looks at the overall country state, import, export, unemployment rates, and much more, so:
- When inflation is high — the prime rate is also increased so it will be more expensive to borrow money
- When inflation is low — the prime rate is also lower, stimulating the economy and improving the attractiveness of borrowing
If we are talking about fixed vs variable mortgages, of course, it will be more profitable to have a fixed mortgage if the prime rate goes sky high. However, there is the same possibility that it can also decrease and you can save money.
What is Variable Mortgage
Now that we are done with the prime rate, let’s talk about one of the participants of our battle fixed vs variable mortgage. A variable mortgage is a loan whose interest rate can be increased or decreased dynamically depending on the situation in the country. If the economy is doing good, there is a chance that the prime rate will be reduced and your mortgage`s interest rate will decrease as well. This option is great for risky people.
Its advantages are:
- Examined historically, variable rates have proven to be less expensive over time
- If it is less expensive you can close your mortgage sooner (but it depends on other terms set by your bank)
However, there are also disadvantages:
- Financial uncertainty. You don’t get any capability to see the final cost of your loan because it is always calculated based on the prime rate and other factors
- This type does not guarantee a fixed period of time when the interest rates usually increase or decrease, which means that it can end up being more expensive at a specific moment in time if the prime rate changes in the future
What Fixed Mortgage Is
A fixed mortgage rate has a fixed interest rate that does not change during the entire term of the loan. In this situation, you have to decide whether you choose a fixed term ranging from 1 to 30 years, but you will know exactly what your final cost will be and obviously, it is much easier for a bank to plan what money they should give you. Remember that if you choose a shorter term, there will be more interest deductions which reduce the final cost.
Fixed mortgage pros:
- You know where you`re going (and when) to pay — no surprises
- Stable prime rate can guarantee less financial burden
However, there are also some cons too:
- Can demand additional payments
- Payments can be really high
Historical Changes in Fixed vs Variable Mortgage
There is a lot of information available on how the prime rate has changed historically and what effect it has on the economy.
In the first half of the 1970s, the variable rate was around 8% and the fixed rate was around 4%. After that, the variable rate went down to 5% and the fixed rate went up to 10%, which means that the variable rate became 2 times cheaper than the fixed rate. Nowadays this situation is not like it used to be, since the average prime rate is 5%-7%, so it’s hard to imagine comparing a 1% difference in two types of mortgages.
If you have professional information about how the situation in the country will change — you can take a risk and take a variable mortgage (if you are sure that the prime rate will drop). If you do not like surprises — the best option for you will be to stick to a fixed mortgage, set auto payment in your online bank, and forget about it.
Fixed vs Variable Mortgage: Conclusion
Depending on what type of person you are, a fixed vs variable mortgage can have different significance for you. If you are looking for the safest option — a fixed mortgage will be the best choice for you. You can also use this type if you are sure about what prime rate will do in the future.
If your decision is based on how many years it will take to pay off your debt — a variable mortgage has an advantage since it can reduce the time of debt pay-off. On the other hand, it is possible that this time period will increase as well which will make it more expensive than a loan with a fixed interest rate. Do not panic, stay in a clear mind and we wish you good luck when buying your new house!