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Fixed vs. variable – which mortgage rate is right for you?

There can be a lot of jargon in the mortgage process, and keeping track of the different products, different dates and different rates can be tough. And because it’s such a big financial step, it’s important to understand these differences so that you’re fully aware of what you’re getting into. One of the first choices to make is whether to apply for a fixed-rate mortgage or a variable one, but how can you decide which is most suitable for you? This short guide sets out what you need to know.

What are fixed-rate mortgages?

When you take out a fixed-rate mortgage, you’re offered an interest rate that doesn’t change for the length of the mortgage term. This means you know from month to month exactly what your repayments will be, making planning and budgeting easier.

It’s important to note that in this context your mortgage term isn’t for the full 25 or 30 years it’ll take to clear the debt. Your rate will be fixed for a much shorter period, typically five years, after which you’ll need to renew your mortgage with a fresh deal.

What are variable-rate mortgages?

With a variable-rate mortgage, you agree that the interest rate can be changed in reaction to movements in the economy. Most often, a variable-rate mortgage will track the Bank of Canada’s prime rate, rising or falling in line with any changes.

If the BOC puts the rate up by one percentage point, your rate will rise by a point to match. Similarly, if the prime rate falls, your mortgage payments will go down too, although there’s usually a specified minimum that your rate won’t fall below.

Why the difference matters

Both types of mortgages have benefits and drawbacks. With a fixed-rate mortgage, you have certainty about your monthly payments, and you can ignore what’s going on in the financial markets for the next few years.

However, the price you pay for this dependability is a higher rate. Your lender will add a point or two to the rate to give them some breathing space if central rates rise.

Variable-rate mortgages are usually more competitive. As the economy grows and interest rates rise further, the amount of interest paid on your mortgage will continue to rise, which could potentially extend the total amount of time it takes you to pay-off your mortgage.

Making the choice

So, which type of mortgage should you choose? First, look at the current rates on offer. Occasionally, you can get fixed-rate deals that undercut their variable equivalents, but this situation is rare. In most cases, a variable-rate deal will be less expensive in the short term.

But that’s not the end of the story. While interest rates stay at their current low levels, the real-world difference in repayments isn’t so huge. But if rates start to rise, variable-rate payers will see their costs rise while fixed-rate payers will remain at their current level.

The decision ultimately comes down to your financial circumstances and your attitude to risk. If you’re comfortable enough to weather a future rate rise, then betting that rates stay low with a variable rate mortgage will save you money for as long as circumstances stay in your favour.

But if you’re on a tight budget and would find the uncertainty of a variable-rate deal stressful, the slightly higher monthly cost of a fixed-rate mortgage might be a price worth paying for peace of mind.

This is a big financial decision and the best thing to do before choosing a mortgage is talking to a specialist. They’ll help figure out which mortgage is right for you and your situation.

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