Are you trying to decide between a fixed and variable rate mortgage? Then you’re watching the right video!
I’ll explain what fixed and variable rate mortgages are. I’ll also share the pros and cons of each mortgage type, including some that may surprise you.
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Full Transcript
Hey everyone, are you trying to decide between a fixed rate mortgage and a variable rate mortgage, you're not alone. It's a decision faced by millions of Canadians each year. In this video, I'll explain what fixed and variable rate mortgages are. I'll also talk about the pros and the cons of each mortgage type, including some that may surprise you. So you'll want to tune in that until the end of this video. The first type of mortgage is a fixed rate mortgage.
With a fixed rate mortgage, your rate as well as your payments stay the same for the duration of your mortgage term, usually five years. This makes it a lot easier to plan for the future, especially if you're a first time homebuyer and you're just getting used to the expenses of owning a property.
That's why many first time homebuyers decide to go with fixed rate mortgages. The second type of mortgage is a variable rate mortgage. Unlike a fixed rate mortgage with a variable rate mortgage, not only can your mortgage rate change, but your payment can change as well. The mortgage rate is based on your lenders prime rate, which typically it changes when the Bank of Canada adjust interest rates.
The Bank of Canada has eight scheduled interest rate announcements a year typically it doesn't change interest rates on all eight of them. But there is the potential for rates to change. This can be to your benefit if the Bank of Canada decides to decrease interest rates, but if they decide to increase interest rates, that could mean not only your mortgage payment going up, but your mortgage rate going up as well. So definitely a good potential to save money if rates are declining. But if rates are going up, that's where it can end up costing you more and affecting your family's cash flow.
Now that you understand what fixed and variable rate mortgages are, let's talk about the pros and the cons of each mortgage type. Now in this video, I'm just talking in general terms before choosing a fixed or a variable rate mortgage for yourself. You'll want to speak with an independent mortgage broker like myself who can do a full assessment of your financial situation to make sure that you choose the right type of mortgage for you. The first benefit of a fixed rate mortgage is that it provides predictability and stability of payment. When you have a fixed rate mortgage, you know exactly what your payment is going to be for the length of your mortgage term, typically five years that makes it a lot easier for budgeting for the future.
The second benefit of a fixed rate mortgage is that fixed rate mortgages typically have simpler terms to understand when compared with variable rates.
As mentioned earlier, once you have your mortgage payment and rate, it will not change for the duration of your mortgage term. Typically, five years with a variable rate mortgage is slightly different. Your mortgage grade can change several times throughout the year depending on what the Bank of Canada does with interest rates. The third benefit of a fixed rate mortgage is what I like to call competence in budgeting. When it comes to expenses in a family's household, there's a lot of surprise expenses that can happen. For example, you could lose your job, your car could break down, or you could unexpectedly have a costly home repair bills such as the roof leaking.
The great thing about having a fixed rate mortgage is that it makes it a lot easier to plan for those unexpected expenses because your mortgage payment and rate are going to stay the same. The fourth and final benefit of a fixed rate mortgage is that you can set it and forget it.
Some people are more risk averse than others. If you fall into that category there and investing in the stock market makes you nervous then a fixed rate mortgage can provide you with a lot of peace of mind. You can basically as I mentioned earlier, once you set up your fixed rate mortgage you set it you can essentially Forget it, you don't have to worry about what the Bank of Canada is going to be doing on its next interest rate announcement which can provide people with a lot of peace of mind. Now that we've talked about the potential benefits of a fixed rate mortgage, let's talk about the potential disadvantage of a fixed rate.
The first potential disadvantage of a fixed rate mortgages and fixed rate mortgages typically come with higher mortgage rates than variable rate mortgages, especially the posted rate, which we'll talk about in the next point which can come back to haunt you, especially if you have a fixed rate mortgage with a big bank. The second disadvantage of a fixed rate mortgage and this is a big one are the penalties. Many people think that fixed rate mortgages are safe and secure and they don't have a worry in the world. But that couldn't be further from the truth, a looming potential danger later on in your mortgage term and this can be a big one What are the penalties when it comes to fixed rate mortgage penalties, the big banks are by far the worst, this isn't something that they advertise. But I've read plenty of articles out there. And I've seen from firsthand experiences huge mortgage penalties, we're talking about the typical big bank mortgage penalty being 15, $20,000. I've heard of the bank mortgage penalties being $40,000 or more, the penalties are especially inflated with people taking on bigger and bigger mortgages with each passing year.
Despite the warning, if you still decide to go with a fixed rate mortgage, my suggestion would be to work with a independent mortgage broker like myself, the benefit of working with an independent mortgage broker is we have exclusive access, we're the only way to access online lenders. online lenders almost always have their fixed rate mortgage penalties than the big banks, that can mean the difference of a penalty of maybe 15, or $20,000 at a big bank versus a penalty of maybe three or $4,000 at an online lender.
So definitely, if you're going with a fixed rate work with a independent mortgage broker like myself, the third and final disadvantage of fixed rate mortgages is that they tend to come with inflexible mortgage terms. If you need to break your mortgage, there's really not a lot that you can do, you're pretty much forced to pay that inflated mortgage penalty. So definitely think long and hard before signing up with a fixed rate mortgage, especially at one of the big banks because it can definitely be a very unpleasant personal finance lesson to have to pay a 15 or $20,000. Penalty. Now that we've covered fixed rates, let's switch gears for a moment and talk about variable rates. We'll go over the pros and cons of variable rate mortgages. We'll start with the benefits of variable rate mortgages.
The first potential benefit of variable rate mortgages is variable rate mortgages usually come with lower mortgage rates than fixed rate mortgages, and everybody likes saving money. So the potential for saving money with a variable rate mortgage is definitely there. And that leads us into our second benefit for variable rate mortgages. Because variable rate mortgages usually come with lower mortgage rates, you can typically qualify to spend more on a home if you are taking on a variable rate mortgage instead of a fixed rate mortgage.
This especially comes in handy if you're buying inexpensive real estate market like Toronto or Vancouver. And the third benefit of variable rate mortgages.
And this is a huge one is that variable rate mortgages almost always come with lower penalties than fixed rate mortgages. When you break a variable rate mortgages, typically your penalty is only three months of interest. Whereas as mentioned earlier, you've have a fixed rate mortgage, the penalty can end up costing you an arm and a leg. And the fourth potential benefit for variable rate mortgages is that variable rate mortgages tend to have more flexible mortgage terms. So when the Bank of Canada lowers interest rates, that means that not only is your mortgage payment going to go down, but your mortgage rate is going to go down as well. That means that you'll be saving money over the term of your mortgage. And there's an interesting study done by a professor at York University here in Toronto, Moshe Milevsky which found that Canadians would come out ahead about 90% of the time when they take a variable rate mortgage. Of course, it depends on where interest rates are going at the time that you sign up.
But definitely there is a huge potential to save money if you sign up for a variable rate mortgage. Now let's talk about the potential disadvantage of variable rate mortgages. The first potential disadvantage of a variable rate mortgage is that your mortgage payment can change. Now if interest rates go down, that means your mortgage payment will be lower, which people like but the reverse is true. If interest rates go up, that means that your mortgage payment can go up.
So before you take a variable rate mortgage, be sure that you can handle increases in mortgage rates because you wouldn't want your cash flow to be super tight if interest rates went up higher than anticipated. The second disadvantage is potentially paying less towards your mortgage principal.
There are two kinds of variable rate mortgages. The first kind and the most common kind is a variable rate mortgage where your payment changes as your mortgage rate changes. The second kind of variable rate mortgage is a variable rate mortgage with a fixed payment. Now this is less common. And the potential benefit is that if interest rates went up, you don't have to worry about your payment going up.
But the potential downside to that is if you choose not to increase your payment, you could end up barely paying down your mortgage at all with most of your mortgage money. Ain't going towards interest and barely anything going towards the principal. And that leads perfectly into our third and final potential disadvantage of a variable rate mortgage is that it could potentially take you years longer to pay off your mortgage if you have a variable rate mortgage with a fixed payment.
If you choose not to increase your payment when interest rates go up, you could find that you didn't even take any time off your mortgage. If you started with a 25 or 30 year mortgage, you could end up having 25 years left when or 30 years left when your mortgage comes up for renewal or even longer than that 35 years 40 years. So if your goal is to pay off your mortgage sooner, definitely think long and hard before going with a variable rate mortgage with a fixed payment. And those are the pros and cons of fixed rate mortgages versus variable rate mortgages.
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