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Is a Variable Mortgage Right For You?

Is a Variable Mortgage Right For You?

Choosing the type of mortgage rate is one of the biggest decisions a borrower will make when selecting their mortgage. In 2022 inflation is rising, leading to higher prices and mortgage rates. We want to help you decide what mortgage rate may be the best option for you depending on your situation and your risk tolerance.

Most often, people choose a fixed rate mortgage because it may seem like the safer decision. But what if I told you, it’s not? Both fixed and variable rates have their pros and cons, and one may suit you better than the other. But first, you need to know the difference between the two types of rates and understand what a variable rate mortgage is.

What is the difference between fixed and variable mortgage rates?

Many people do not like change, so the fixed-rate mortgage sounds like a no-brainer! But what if change in the short term will save you money over time? Before you determine your choice of rate, let’s break down the difference between the two. With a fixed-rate mortgage, the interest rate and payment you make each month will stay the same for the term of your mortgage. However, with a variable-rate mortgage, the rate will change with the prime lending rate as set by your lender. If the interest rates rise, the amount paid towards the principal will drop, and if the interest rate decreases, your principal payments will rise, allowing you to pay off your mortgage faster and save money on interest!

Variable rate mortgage

Let’s talk about a variable rate mortgage. The Bank of Canada makes the decision to increase the prime rate depending on the overall state of the economy and the goals to stabilize the country’s financial position.  

It’s important to know that the commercial bank (RBC, Scotiabank, Coast Capital, etc.) prime lending rate is different than the Bank of Canada overnight lending rate. For example, at the time of writing the commercial bank prime lending rate is 2.2% higher than the Bank of Canada overnight rate. It may seem like a lot, but keep in mind that right now most variable rate mortgages are being offered at a discount from the prime rate, often referred to as a “prime minus”. The current commercial bank prime rate is 4.70% and the country’s leading analysts project that the peak will be 5.45% (3.25% + 2.20% spread). For a lender to arrive at your specific variable mortgage rate, they will offer the prime rate, plus or minus the difference in their forecast return. For example, a variable rate could be quoted as prime -0.80, so when the prime rate is 4.70%, you will pay 3.90% interest. The thing to remember is that even when the prime rate varies, your discount from that rate will stay the same throughout the term of your mortgage. Seems less scary, right?

Let’s look at the difference in payments over a five-year period for homebuyers depending on if they selected a fixed or variable mortgage rate.           

 5-year Fixed Mortgage 5-year Variable Mortgage
 Rate: 4.54%
25-year Amortization
$2,848.54 monthly payments  
 Rate: 4.45%
25-year Amortization
$2,630.10 monthly payments  

At the end of the 5 years, the variable rate mortgage client has $13,105 more in their pocket compared to the fixed rate client. The prime rate would have to rise by more than 0.80% over 5 years for the variable rate client to pay as much as the fixed rate client. And unless the rate rose by that much all at once, the variable rate client would still be paying off more of their principal balance.

The whole point is to spend less and save more long-term. A prepayment strategy may change your view on a variable rate. This strategy will show you how to lower your risk on a variable mortgage while also setting up long-term to save on interest. You’ll use your prepayment privilege to increase your variable mortgage payments to the same payment you would be making at a higher 5-year fixed rate mortgage. By doing this, not only are you at lower risk but also paying down your mortgage faster! It buys you time later in the term when rates are more likely to increase.

Eventually, if the prime rate rises high enough to bring your payments to the level you have increased, you could simply remove the additional prepayment. You would have made substantial progress on paying down your mortgage. And it could take some time for you to end up paying more for the variable rate increase because of how much you have paid towards the principal in advance.

The difference between an Adjustable Rate Mortgage and a Variable Rate Mortgage

Think of an adjustable rate mortgage (ARM) as a sub-type of variable rate mortgages. Like a typical variable mortgage, an adjustable rate mortgage is based on the lender’s prime rate. However, an adjustable rate mortgage will automatically change your payments if the prime rate changes. The payment for a variable product remains the same for the duration of the mortgage term. With a variable rate mortgage, your payments will only change in the unlikely case that prime rises so much your payments no longer cover the interest charges. This is known as the trigger point. With either solution, you can still convert to your mortgage into a fixed rate mortgage at any time.

Finding Your Best Mortgage Rate

It might seem like a variable rate is less pleasing because of how things look short-term. But what if you think of a variable rate over the long-term? It has been proven that over time, a variable rate mortgage will save you money! Some of the benefits of a variable rate are:

  • The rate is determined using a difference from the Prime Rate. The variable rate is typically lower than fixed but can also float higher for some periods.
  • If you decide to break your mortgage, the penalty is far lower than for a fixed rate.
  • You can lock the variable rate into a fixed rate at any given time without breaking the mortgage.

Choosing the right mortgage rate all comes down to your unique situation and how much risk you are willing to take. Here are some questions to think about when making this decision:

  • Are you comfortable knowing that the variable rate may continue to increase?
  • If your plans change, are you ready to pay the penalty if you break your mortgage term early?
  • Given your financial goals, does it make sense to lock into a 5-year fixed rate in the mid 4% – 5% range?

Ready to find out whether a variable rate mortgage is the right solution for you? Our team is here to help. Fill out our contact form or give us a call at 250-590-6520 (toll-free 1-855-590-6520) to see how we can find the best solution for your situation.

Contact us

Auxilium Mortgage Corporation is based in Victoria, BC and works with clients locally and across Canada. The Auxilium team has over 100 years of combined financial experience and access to dozens of lenders to help you meet your goals.

This post reflects the best available information at the time of writing/last update. To ensure that you have the most up-to-date information, contact us to confirm the details for your specific situation.

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