The Full Guide to Fixed Rate Mortgages in Canada

What is a Fixed Rate Mortgage

A Fixed Rate Mortgage (FRM) offers stability and simplicity in the home buying process by setting the interest rate and monthly payment amounts to remain constant throughout the term of the loan. This traditional form of mortgage financing stands in contrast to Adjustable Rate Mortgages (ARMs), where the interest rates and payments can fluctuate over time based on market conditions. For example, consider purchasing a home with a FRM at a 5% interest rate for a seven-year term. This means, irrespective of market rate fluctuations, both your interest rate and monthly payments are “locked in” at the onset, ensuring predictable and unchanged payments throughout the duration of the term.


Fixed vs. Variable Rate Mortgages

The primary difference between fixed-rate and variable-rate mortgages revolves around how the interest rate on the mortgage is handled over the term of the loan. In a fixed-rate mortgage, the interest rate is set at the beginning and remains unchanged for the entire term of the mortgage. This stability means that the homeowner’s monthly mortgage payments are predictable, making budgeting easier. Fixed-rate mortgages are particularly appealing when interest rates are low and are expected to rise, as they allow homeowners to lock in a lower rate for the duration of their mortgage term.

On the other hand, variable-rate mortgages have interest rates that can fluctuate over the term of the loan, usually in line with changes to market interest rates. The rate on a variable mortgage is often tied to a benchmark interest rate set by the bank, plus a fixed margin. This means that monthly payments can vary, going up or down, depending on how the benchmark interest rate changes. Variable-rate mortgages can be advantageous when interest rates are expected to decrease, as they allow borrowers to benefit from falling rates. However, they also carry the risk of increasing payments if interest rates rise.

Choosing between a fixed and variable rate mortgage often comes down to personal preference, financial stability, and predictions about future interest rate movements. Those who prefer predictability and stability, or anticipate an increase in interest rates, may opt for a fixed-rate mortgage. Conversely, those willing to take on some risk for the potential of lower rates may find a variable-rate mortgage more appealing.

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Economic Factors Influencing Fixed Rates

In Canada, the setting of fixed mortgage rates by banks is largely influenced by the bond market, specifically the yield on Canadian government bonds of corresponding maturities. Essentially, if a bank is offering a five-year fixed-rate mortgage, it will closely look at the yield on five-year government bonds to help determine the interest rate to charge. The bond yields act as a benchmark for the banks, guiding them on the cost of borrowing money at a fixed rate over a certain period.

When bond yields rise, banks typically face higher costs to borrow money, which they often pass on to consumers in the form of higher fixed mortgage rates. Conversely, when bond yields fall, the cost of borrowing decreases, allowing banks to offer lower fixed mortgage rates. This correlation is due to the direct competition between government bonds and bank mortgages for investors’ money; both are considered relatively safe investments, but investors will naturally prefer the one that offers a higher return.

Moreover, banks also consider their operational costs, profit margins, and the competitive landscape in the financial market when setting their fixed mortgage rates. Economic factors such as inflation, unemployment rates, and overall economic health, as well as monetary policies set by the Bank of Canada, can also influence interest rates, albeit indirectly. The decision on the final mortgage rate involves a blend of responding to market conditions, ensuring profitability, and attracting consumers in a competitive marketplace.

Choosing the Right Mortgage

Choosing between fixed and variable rates for your mortgage involves considering your financial situation, risk tolerance, and future market predictions. Fixed rates offer stability and predictability, as your interest rate and monthly payments remain constant throughout the term. This makes budgeting easier and provides peace of mind, especially if you’re on a tight budget or if current interest rates are particularly low and expected to rise. A fixed-rate mortgage shields you from interest rate hikes but may come at a higher cost initially compared to variable rates.

On the other hand, variable rates fluctuate with the market, meaning your interest rate and monthly payments can go up or down. This option might be suitable if you have some flexibility in your budget and can handle potential increases in payments. Historically, variable rates have been lower than fixed rates over the long term, offering potential savings if interest rates decrease or remain stable. However, this comes with the risk of rates increasing, which can raise your monthly payments.

The choice ultimately comes down to a personal preference balancing between the need for financial stability and the willingness to take risks for potential savings. If you prefer knowing exactly what your payments will be, a fixed-rate mortgage might be the way to go. If you’re comfortable with uncertainty and think you can handle potential rate increases, a variable-rate mortgage could offer long-term savings. Assessing your financial goals, consulting with a financial advisor, and keeping an eye on economic forecasts can help you make an informed decision.


Historical Perspectives on Fixed vs Variable Rate Mortgages

Historically, variable rate mortgages have often outperformed fixed-rate mortgages in terms of overall cost savings for borrowers. This is primarily because variable rates, which fluctuate with the market, tend to be lower on average over the long term compared to fixed rates, which are set at the outset and remain constant regardless of market changes. A significant study by Dr. Moshe Milevsky of York University in 2001 found that, in Canada, homeowners with variable rate mortgages paid less interest compared to those with fixed-rate mortgages over time. The study examined Canadian mortgage rate patterns over several decades and concluded that choosing a variable rate would have been more financially advantageous in the majority of cases.

This historical trend is attributed to the fact that central banks, including the Bank of Canada, adjust policy rates down more frequently or keep them lower for longer periods during times of economic uncertainty or to stimulate the economy. However, it’s important to note that past performance does not guarantee future results. The effectiveness of choosing a variable rate mortgage over a fixed rate can vary depending on the timing of the mortgage, the specific terms of the mortgage agreement, and the economic conditions over the mortgage period.

Moreover, while variable rates have historically been the cheaper option over the life of a mortgage, they come with the risk of rate increases, which can raise monthly payments. This risk is something that borrowers need to consider based on their financial situation and risk tolerance. In periods of low-interest rates, locking in a fixed rate might seem more appealing to those seeking stability and predictability in their monthly payments. The decision between fixed and variable rates should be made after carefully considering one’s financial circumstances, future outlook on interest rates, and personal preference for financial stability versus potential savings.

Pros of Fixed Rate Mortgages:

Predictability: The most significant advantage of a fixed-rate mortgage is the predictability it offers. Since the interest rate remains the same throughout the term of the loan, your monthly mortgage payments are also constant. This makes budgeting easier, as you know exactly how much you need to set aside for your mortgage payment each month, without worrying about fluctuating interest rates affecting your payments.
Protection from Rising Interest Rates: With a fixed-rate mortgage, you’re protected from any future increases in interest rates. If the market rates go up, your interest rate and monthly payments stay the same, saving you money compared to variable rate mortgages where payments would increase with rising interest rates. This can be particularly beneficial in a low-interest-rate environment where rates are expected to rise.

Cons of Fixed Rate Mortgages:

Higher Initial Interest Rates: Fixed-rate mortgages often start with a higher interest rate compared to variable rate mortgages. This means that if interest rates remain stable or decrease, you could end up paying more over time compared to if you had chosen a variable rate mortgage. This higher initial rate is essentially the price you pay for the security and predictability of a fixed rate.

Penalties for Early Repayment: Another downside of fixed-rate mortgages is the potential for higher penalties if you decide to pay off your mortgage early, especially if you break your mortgage contract before the term is up. These penalties can be costly and are typically higher than those associated with variable-rate mortgages. The reason for this is that lenders stand to lose more in interest with a fixed-rate mortgage being paid off early, compared to variable-rate mortgages where the interest rate risk is shared between the borrower and lender.

In summary, fixed-rate mortgages offer stability and protection against rising interest rates, making them a great option for those who value predictability in their financial planning. However, the trade-offs include potentially higher initial interest rates and penalties for early repayment, which could be significant depending on the terms of your mortgage. Careful consideration of these factors is essential when deciding if a fixed-rate mortgage is the right choice for you.
If you’d like to discuss further on which interest rate type is right for you, reach out to my office and either myself or one of my senior mortgage agents will be happy to help. 519-250-4848 – [email protected].

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