More than ever homeowners are researching mortgage options more actively and reach out to me for additional information and advice on a daily basis. With interest rates outside of client’s comfort levels combined with non-stop talk from friends, family, colleagues, on top of social media and the “news”, it is no wonder many are finding themselves overwhelmed.
Whether you are a first-time home buyer, or researching your upcoming renewal, selecting the right mortgage product is not always an easy decision to make. You need to consider the features of each mortgage type, along with your personal needs and how the features of each of the mortgage options best benefit your needs.
On top of this, one needs to have the proverbial “crystal ball” to guess what interest rates will be in the near, mid and longer term. Unfortunately, no one, including myself, possesses a crystal ball, so it is more an exercise in educating yourself, which includes discussion with myself to go through the process of identifying your needs and weighing the risk and benefit of each option compared to the others.
The following is an outline of the basic term options and some of their features and potential options.
Fixed Rate Mortgages: Predictible
Historically the majority of borrowers elect to have fixed rate mortgages. Once you sign onto a fixed rate mortgage, your rate and associated payments are guaranteed for the term of the mortgage. If interest rates increase, you are safe, no need to worry, no need to watch what rates are doing, at least for a few years. Because fixed-rate mortgages are not directly impacted by changes to the Bank of Canada policy rate decisions, unlike variable rate mortgages you rate will not increase however you do not benefit from any cuts by the Bank of Canada. For good or bad that is your interest rate and associated payment until your next renewal date.
When is a Fixed Rate Mortgage the best option?
- This option is best suited to those who prioritize stability, where having a guaranteed known payment is important.
- Those who plan on staying in their home for at least the full duration of the term.
- When you believe that interest rates are trending upwards, or think they will go up in the future.
Main Benefits of a Fixed Mortgage Rate:
- Guaranteed payments for the term of your mortgage
- Guaranteed rate and insulation from potential rate increases.
- Peace of mind
Potential Downfalls of a Fixed Mortgage Rate:
- If interest rates decline, you will be locked into a higher rate.
- Fixed rates have the danger of having elevated pre-payment penalties compared to variable rate mortgages.
- FOMO if rates decline and you can’t take advantage of decreasing rates.
Variable-rate mortgages: Flexibility with Uncertainty
Variable rate mortgages fluctuate with the Prime interest rate that your lender sets. Your lender typically follows lock step with the Bank of Canada rate decisions. If the Bank of Canada lowers the overnight rate, then your lender should drop their Prime rate accordingly and conversely raise Prime if that is the direction that the Bank of Canada takes
While your interest rate can fluctuate, typically your payment will stay the same, which will affect the ratio of interest versus the principal portion of your payment. The only instance where your payment will change is when the interest payment exceeds your regular payment. This is known as the trigger rate, and some people with Variable Rate Mortgages experienced this in 2022 and 2023 when the Bank of Canada rapidly increased the overnight rate.
When is a Variable Rate Mortgage the best option?
- Variable Rate Mortgages may be attractive to those willing to take some risk.
- For those who believe that interest rates will decrease over the term of the mortgage.
- If you are potentially selling your home or may possibly need to refinance before the end of the term, as the penalties for breaking the mortgage are usually lower than for a fixed mortgage.
Main Benefits of a Variable Rate Mortgage:
- Historically rates have proven to be lower than fixed rate mortgages on average.
- Take advantage of decreases to Prime
- Lower pre-payment penalties when breaking the term of your mortgage early.
Potential Downfalls of a Variable Rate Mortgage:
- Payments can increase if rates increase high enough.
- Can cause anxiety for those that aren’t comfortable with risk.
- You can end up paying off less principal than expected if rates increase.
Adjustable Rate Mortgages: Wait, didn’t we just cover that?
Here is a new one for you. Like a Variable Rate Mortgage, the interest rate fluctuates with Prime but how it differs, is that your payment will also fluctuate with changes to Prime. The majority of lenders only offer Variable Rate Mortgages but a few lenders do offer Adjustable Rate Mortgages.
When is the Adjustable Rate Mortgage your best option?
Adjustable rate mortgages may appeal to those who want to keep their principal payment consistent while the interest cost and overall payment fluctuates. As is the case with Variable Rate Mortgages the pre-payment penalties are typically lower than with that of a comparable fixed rate mortgage.
Main Benefits of an Adjustable Rate Mortgage:
- Greater Flexibility
- Potential of the payment to decrease if interest rates decline.
- Lower pre-payment penalties
- Scheduled paydown of principal
Potential Downfalls of an Adjustable Rate Mortgage:
- Payments can increase substantially if rates increase accordingly.
- Uncertainty with both interest cost and payments
So which mortgage is the right one for you?
Ultimately it will come down to a combination of your personal risk tolerance, what your goals are and how long you plan to stay in your home, just to name a few.
A free Mortgage Consultation can tell the tale.
During our conversation we will discuss all aspects of your individual needs coupled with the current rate environment and together we will put together a mortgage plan uniquely tailored to meet your goals.