Every question you may have about Variable Rate Mortgages answered!
When you apply for a mortgage, most of the time you will be given the choice to either fix your mortgage rate for the entire term, or you can select a rate which will vary over the term of the mortgage. These variations occur with changes to the Bank of Canada Prime Rate.
So a variable rate mortgage will increase if the Prime Rate goes up and will decrease if the Prime Rate goes down.
Canadians tend to be risk averse, so most choose a fixed rate mortgage. They don’t want uncertainty. This is true even though that in recent years it proved to be a better financial move to select a variable rate mortgage.
Variable rate mortgages almost always start out lower than the fixed rate offerings, and as rates have consistently dropped since the early nineties, they have proven to be a winning approach.
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People typically care about these things:
- flexibility – you can stay variable while it suits you, and can convert to a fixed rate mortgage at any time.
- low cost to break a variable rate mortgage. Most of the time it will only cost you 3 months’s interest prepayment penalty. A fixed rate mortgage can incur penalties several times larger.
- lower initial payments. The wider the spread between a fixed and variable rate mortgage, the more attractive is the variable rate. In early 2022, the spread is more than 1.5%. This is a significant factor!
This page explores the most common questions which arise about variable rate mortgages in Canada, as well as their pros and cons.
Archive of Variable Rate Mortgage Questions
What are variable rate mortgages?
These are home loans where the interest rate is subject to change during the term of the loan. In the same way your line of credit interest rate might change. Variable mortgage rates change in lockstep with changes to the Bank of Canada Prime Rate. Since the early days of the pandemic in the Spring of 2020, the Prime Rate has only been 2.45%. This has resulted in variable mortgage rates between 1% and 1.5%, which is really compelling.
The catch is that variable means just that – the rate may vary and so will the interest you have to pay. And your monthly payment may change too.
As a result, they are not everybody’s cup of tea. Many Canadians prefer the peace of mind and certainty of a fixed rate, fixed payment mortgage loan.
How often does a variable rate mortgage change?
That’s one of the issues. There is no set schedule or time table. At the time of writing this, the Prime Rate has not changed in almost two years since the early days of the pandemic. (March 31 2020 it dropped to 2.45%)
That is pretty fixed and flat!
And prior to the pandemic, the Prime Rate had remained constant at 3.95% for more than two years. (October 2018 to March 2020) But then it dropped three times in three weeks in March of 2020 – each time by 0.5%.
So the changes are not predictable in their frequency or magnitude. And THAT is why many borrowers prefer a fixed rate mortgage.
Which is better – a variable rate or a fixed rate mortgage?
Neither is actually! We’ll only know well after the fact. And even then, who knows? Borrowers with a variable rate mortgage always have the ability to convert to a fixed rate mortgage at any time – so even if rates climb a great deal, many VRM borrowers will jump ship.
In my view, the decision should not be based on your favorite economist’s view of interest rates over the next several years – since no one ever seems to be right about that!
If I sense I am with a conservative who really would not have the stomach for rising rates with a VRM, I nudge them towards fixed. Peace of mind is a very comforting thing.
If they have no strong feelings on the matter, or are looking to us for advice, we would more than likely steer them towards a fixed rate mortgage too. That does not mean we are pessimistic about the outlook for interest rates. It just makes sense not to direct people towards uncertainty if we don’t have a good reason to.
Should I convert from a variable rate to a fixed rate?
The Prime Rate has been so low for so long, many VRM borrowers have forgotten that the “V” in VRM stands for variable! It is understandable to feel nervous… but do not panic!
If you don’t have the stomach for rate increases (you know who you are or you may one day find out) the option to convert your VRM to a fixed rate mortgage any day, any time is there for you.
The catch of course being, you locked yourself in for a five year relationship with your mortgage lender; so you are not going anywhere without incurring a prepayment penalty. This also means there is no incentive for your lender to offer you their absolute lowest, best five year rate at this time. You are not exactly in a power position.
So, whenever I am asked if I prefer variable versus fixed rate mortgages for a client, I usually bring the discussion back to them, not to me. I have never been a fan of predicting interest rates, and look skeptically at those who do.
- If your mortgage balance is small, relative to your overall finances, why panic? Enjoy the big discount you have over your neighbours’ rates, and get on with your life.
- If you are risk averse, and want the comfort of knowing exactly what your mortgage payment is going to be for the next five years, then consider the fixed rate approach. Let others worry about rising interest rates.
- If your finances would become intolerable with rising rates and mortgage payments, this may be another reason to have a locked-in, fixed rate mortgage.
What percentage of borrowers choose a variable rate mortgage
Historical data sggests only 25% to 30% of borrowers choose a vrm, but we can tell that in our client base the last couple of years that percentage is more like 50% to 60% have chosen variable. At the time of writing (early 2022) there is lots of talk about rates rising in general. This ,may result in the percentage of variable rate mortgages going back to historical norms.
What are the best things about a variable rate mortgage?
The payments are typically much lower than a fixed rate mortgage. If they are not, you need some other good reason for choosing variable.
The ability to break the mortgage with a relatively small prepayment penalty is attractive. Perhaps you plan to sell in the next few years or you want to keep all your options open – then this can save you lots of money.
You can have your cake and eat it too. Stay below the fixed rate mortgage and at any time you may switch to a fixed rate mortgage if you are no longer feeling secure in the variable mortgage product.
Are variable rates higher for a rental property?
Yes, typically banks and other mortgage lenders will charge a slightly higher rate if the property you are buying or refinancing is an investment property. The range will be mostly 0.1% to 0.25% higher.
What is an adjustable rate mortgage?
Adjustable rate mortgages are a specific type of variable rate mortgage. The mortgage payment is adjusted with each change to the Prime Rate…ensuring that your amortization period and your expected balance owing at the end of your mortgage term does not deviate from your original expectations.
A true variable rate mortgage will vary the rate but hold the payment constant – the result being it helps out borrowers who want to be sure of their monthly payment from one month to the next , but it does mean the expected balance owing at the end of your mortgage term will not be what you thought when you first took the mortgage.
How many times will interest rates increase in 2022?
The Federal Reserve in the USA and the Bank of Canada are both concerned about inflation. They also remind us the reason rates have been really low this past two years is to protect the economy during the dark days of the pandemic.
In March 2020, the Bank of Canada dropped the Prime Rate three times quickly in chunks of 0.5%, and we went from a Prime Rate of 3.95% to 2.45% in the space of a few weeks.
That was dramatic and swift due to extraordinary generational type circumstances.
The Fed and the BOC will do whatever is necessary to tame inflation. At this point, in the USA talk is they will raise rates four to seven times. Canada does its own thing, to an extent, but can be expected to watch the USA closely and not deviate too much from their approach.
It will mean higher borrowing costs for mortgages but not necessarily bad for the stock market. Morning Brew reports “rising interest rates don’t always spell doom for the stock market. Quite the opposite, in fact.
The S&P 500 has delivered positive returns in 11 of the 12 Fed rate hike cycles since the 1950s, according to Truist co-chief investment officer Keith Lerner. Why? Because the Fed tends to raise interest rates when the economy is growing, and a growing economy tends to be good news for corporate earnings.”
Time will tell, but it feels like the Bank of Canada has given us all a “heads up”about rising rates, and that we will see actual increases commencing the Spring of 2022.
Which lenders have variable rate mortgages with fixed payments?
TD, RBC, BMO, HSBC and ICICI Bank offer a mortgage where the payment is set for the term of the mortgage, even if the Prime Rate varies. As we learn of others, we will add them to this list.
Of course, if your variable mortgage payment is static or fixed, this means your amortization period is unknown.
It is possible you could end up in negative amortization territory. This happens when you are only repaying interest and no principal – and in fact if your interest component is bigger than the static payment.
Lenders will likely ask you for a lump sum prepayment if that occurs.
My calculations are such that if your payment was set when the variable mortgage rates were 1.35% or less, then you will hit negative amortization somewhere when the actual rate of your mortgage is now between 4% and 4.5%.
If Prime goes up before my closing date, will my variable mortgage payment increase?
Yes, it will increase if you have the type of variable mortgage where the payment changes every time the Prime Rate Changes. The change is immediate, without delay.
If you have a fixed payment variable rate mortgage (like say from BMO or TD Bank), the amount of interest you will pay to the bank over the term of your mortgage will end up being the exact same either way.
If your mortgage funds just prior to the Prime Rate increase, you can preserve the lower payment, but of course if the Prime Rate increases so does the rate on your mortgage – you just won’t be aware of it till the mortgage matures when there is more principal owing than had you started at a higher rate/payment structure.
We do have a few clients doing refinances this month and are trying hard to get done before the next possible Bank of Canada rate increase…in their case, cash flow is crucial. You and Meaghan have pretty great cash flow though.
Will my variable mortgage payment increase after a Prime Rate increase?
CTV news quoted our colleague Ron Butler. “A majority of Canadian homeowners with variable-rate mortgages can expect to see an increase in their monthly payments within the month following an interest rate hike by the Bank of Canada, he said.
But the remaining portion – which Butler estimates to be 40 to 45 per cent of Canadians – likely won’t see a change in their payment total, but instead a reduction in the amount of principal being paid. While the mortgage payment stays consistent, Canadians in this situation would be paying more in interest based on increases implemented by the Bank of Canada. This could then impact the amount of time it would take to pay off their mortgage.”