When it comes to shopping for a mortgage, it is a good idea to understand the difference between a fixed interest rate and a variable interest rate. Although your broker can help you identify which kind of rate best suits your situation, it’s beneficial for you to know exactly what that rate means for you.
A fixed rate mortgage is the most popular interest rate option. With a fixed interest rate, the mortgage payment you make each month will stay constant for the term of your mortgage. For example, if you lock in a 5 year fixed rate of 3%, your payments will be principal plus 3% interest for the next 5 years. When those five years are up, your mortgage must be renewed. At that point, you can work with your broker to secure a new interest rate at a term that best suits your needs.
With a variable rate mortgage, the interest rate is subject to fluctuate according to the prime lending rate set forth by your lender. Your payments will always be prime plus or minus a specified amount. For example, on July 15th, the Bank of Canada dropped their overnight lending rate and lenders, in turn, put forth a small decrease in their prime lending rates. Those with variable rate mortgages were affected – as prime had changed – however, those with fixed rate mortgages were not affected because their interest rates are not affected by the prime lending rate.
The biggest advantage of using a fixed rate over a prime rate is that you know exactly what your payments will be for the term of your mortgage; there are no surprises. Although this rate is usually a little higher than the variable rate at the time of signing, some people prefer the security of knowing what their payments will be over the chance of saving some money.
Conversely, the biggest advantage to variable rates is that you may end up paying a lower amount of interest than you would with a fixed rate. The downside is that you are taking on the risk of having a fluctuating mortgage payment, so it may be difficult to budget ahead.