Choosing the right mortgage: Fixed vs. Variable-rate mortgages

Toronto real estate intelligence: deciding on a mortgage that’s right for you.

With all the interest hikes we’ve seen lately, the question on every homeowner’s mind is: do I have the right kind of mortgage? Should I switch? How do I save the most money over time? And for those buying real estate in Toronto right now, the choice between fixed and variable can be a tough one. Paying less now but maybe more later? Or riding the variable wave until we hit a lower-interest shore? There’s a lot to understand here. 

First off, though, let’s start with the basics: what fixed and variable rates actually mean when it comes to mortgages. 

Variable vs. Fixed-interest 101

A fixed-rate mortgage gives you one interest rate for the full term of your mortgage, usually 1-5 years. For homeowners looking for predictable payments, this is a popular choice: your payments stay the same every month until your term is up, and then you renegotiate a new rate for the next term. 

Usually, that predictability comes with a price tag: the interest rates on fixed products have traditionally been higher than they are for variable. But right now, fixed rates have actually dropped lower than variable rates. And here’s why: lenders are counting on interest rates coming down sooner rather than later. By offering more attractive fixed rates now, they will ultimately end up with more people locked into payments that are higher than posted rates – and that’s where they’ll make their money. 

A variable-rate mortgage offers flexibility – and comes with greater risk. Rather than being locked into one interest rate for the term of your loan, your payments are based on the posted rate. That doesn’t necessarily mean you pay more or less every month, though: many borrowers opt for consistent monthly or biweekly payments (or a fixed payment schedule) – what changes is the amount going to interest and principal. 

So if posted rates stay the same or go down, it’s cheaper than a fixed rate. However, (and here’s where the risk comes in) if rates go up, you pay more. Over the last few months, variable-rate borrowers have seen the downside of taking that risk. They’ve been paying more in interest and less towards principal, and many have hit their “trigger rate,” with payments no longer covering enough principal, so their monthly payments have gone up.

Read more: What is your trigger rate and how does it affect your variable-rate mortgage?

One major benefit to variable mortgage products is that they’re flexible. If you decide to break your variable-rate mortgage, you’ll only pay 3 months’ interest as a penalty. With a fixed-rate mortgage, you’ll pay MUCH more to break the contract – often tens of thousands of dollars. (It’s designed that way so people don’t cut and run when rates drop.)

So which mortgage is right for me, right now? 

Interest rates haven’t been this high since the turn of the century. The number and speed of Bank of Canada increases took a lot of people by surprise: a lot of homeowners who were sailing along with low variable rate mortgages have been hit with significantly higher monthly costs. And not everyone can afford to pay hundreds – or thousands – more every month.

Homeowners and buyers who can afford their payments have a few options: 

Option 1: Do nothing and keep paying the variable rate. When inflation eases and the economy starts to cool, the Bank of Canada will cut rates to avoid a recession. When they’ll do that and by how much remains to be seen – it could be as early as the end of 2023, or sometime in 2024.

If you can afford the higher payments, staying the course could pay off, because you’ll start benefiting from lower rates as soon as they’re announced. (Plus, if rates come down and you keep your payments high, you’ll pay off your mortgage faster.) 

Option 2: Break your variable-rate mortgage and move to a fixed-rate. Locking in will mean  you’ll pay a lower monthly rate – until rates come down. The longer you lock in for, the better the rate. But you will pay a 3-month penalty for breaking the variable mortgage. So if you’re switching to a 1- or 2-year fixed, that penalty will probably nullify any savings you might see from switching to the lower rate. 

Lock into a 5-year rate, and you’ll be paying the same rate for 5 years, no matter how much interest rates drop. You won’t have to worry about unexpected expenses and your payments will be predictable for the term of your loan. But if you want to break that mortgage, it’ll cost you thousands. 

Get good one-on-one advice

Always, always, always talk to a trusted mortgage professional before making any big decisions. We recommend speaking to a mortgage broker rather than someone at a bank. The bank is all about maximizing how much they make off your loan, so they may not give you the best advice. On the other hand, a broker doesn’t have those kinds of ties and is more likely to recommend what’s best for YOU. Plus, brokers tend to be more experienced than someone at your bank branch, and have access to more products. 

Getting the right mortgage comes down to getting educated, understanding your risk tolerance, and talking to an expert who can help you figure it all out. Need some mortgage advice around buying real estate in Toronto? I’m always happy to recommend a trusted broker. Give me a shout and I’ll connect you!