The choice between a variable and fixed rate mortgage is one of the most common questions buyers ask — and one that receives a lot of bad advice, usually in the form of predictions about where interest rates are heading. We are not going to tell you where rates are heading. Nobody knows with certainty, and acting on a prediction rather than your own financial situation is how people get into trouble. Here is a more useful framework.
How fixed rate mortgages work
A fixed rate mortgage locks your interest rate for the term — typically 1, 2, 3, or 5 years in Canada, with 5-year fixed being the most common. Your interest rate and payment amount do not change during that term, regardless of what happens to interest rates generally. At the end of your term, you renew at the prevailing market rate.
Fixed rates provide certainty. You know exactly what your payment will be each month for the duration of your term. This makes budgeting straightforward and eliminates the risk of your payments increasing if rates rise.
The trade-off is that fixed rates are typically set higher than variable rates to compensate the lender for absorbing that rate risk. If rates fall significantly during your fixed term, you are locked in at the higher rate (unless you break the mortgage, which carries a prepayment penalty — often substantial).
How variable rate mortgages work
A variable rate mortgage has an interest rate that fluctuates with your lender's prime rate, which tracks the Bank of Canada's overnight rate. Your rate is typically expressed as prime plus or minus a spread (e.g., prime minus 0.50%). When the Bank of Canada raises or lowers its rate, your mortgage rate adjusts accordingly.
There are two types of variable mortgages in Canada: those where the payment amount stays the same but the allocation between principal and interest shifts (adjustable payment), and those where the payment itself changes when the rate changes (variable payment). Confirm which type your lender offers.
The decision framework
Rather than trying to predict rates, ask yourself these questions:
- Can you absorb higher payments if rates rise? If your budget is tight at the current rate, a variable mortgage that adds several hundred dollars per month to your payment in a rising rate environment would create real financial stress. Fixed rate mortgages eliminate this risk.
- What is your timeline? If you plan to sell within a few years, a shorter fixed term or a variable rate with a lower prepayment penalty may cost less overall than a 5-year fixed.
- What is your risk tolerance? Some people sleep better with the certainty of a fixed rate. Others are comfortable with variability in exchange for the potential of a lower rate. Neither preference is wrong — they just require different products.
- What does your mortgage broker say? A good mortgage broker will look at your specific income, debts, employment situation, and risk profile before making a recommendation. That personalized advice is worth far more than any general article, including this one.
The stress test applies to both
Regardless of which type you choose, Canadian lenders are required to qualify you at the higher of your contract rate plus 2%, or 5.25%. This stress test is designed to ensure you can manage your mortgage even if rates increase. It applies to both fixed and variable mortgages.
One practical note on prepayment penalties
If there is any chance you will need to break your mortgage before the end of your term — due to selling, refinancing, or life changes — understand the prepayment penalty structure before you commit. Fixed rate mortgages typically carry an Interest Rate Differential (IRD) penalty that can be very expensive. Variable rate mortgages typically carry a three-month interest penalty. This asymmetry matters if flexibility is important to you.
We work with trusted mortgage brokers who can walk through these options with your specific numbers. If you'd like an introduction, reach out to us.
