When buying a home or shopping for a mortgage, a key decision is whether to choose a fixed-rate or variable-rate mortgage. Let’s explore the differences, benefits, and downsides of each to help you make an informed choice.

Fixed-Rate vs. Variable-Rate Mortgages

Fixed-Rate Mortgage

• Rate and Payment- Both stay the same throughout the mortgage term.
• Stability - Offers predictable monthly payments, making budgeting easier.

Variable-Rate Mortgage

• Rate and Payment - Changes with the prime lending rate set by your lender, quoted as Prime +/- a certain percentage (e.g., Prime - 0.45%).
•  Payments can vary with prime rate fluctuations.

5-Year Fixed vs. Variable Mortgage Rates Over Time

Variable rates are usually slightly lower than fixed rates since they carry less risk for lenders. However, this isn’t always true. In late 2019, 5-year variable rates were higher than fixed rates, and by the end of 2022, the gap between the two was almost non-existent. Throughout 2024, 5-year variable mortgage rates have been noticeably higher than 5-year fixed rates.

Pros and Cons of Fixed & Variable Mortgage Rates

Fixed Mortgage Rate

• Set for the mortgage term. Both rate and payments are fixed.

Variable Mortgage Rate

• Fluctuates with the market interest rate (prime rate). Payments or interest portion of payments vary. 

Pros

• Stability and predictability, making budgeting easier.
• Historically less expensive over time.

 Cons

• May not be worth paying a premium for stability if variable rates are significantly lower.
• Financial uncertainty if prime rate increases, raising your payments.

Popularity Trends

Historically, fixed mortgage rates are more popular. However, in 2021 and 2022, lower variable rates led to a surge in variable-rate mortgages. Over 50% of new mortgages in late 2021 were variable-rate. After eight rate hikes by the Bank of Canada from March 2022 to January 2023, variable rates soared, and their popularity dropped. By the end of 2023, variable-rate mortgage requests were just over 5% of all requests on by some lenders. The 2024 CMHC Mortgage Consumer Survey shows 23% of consumers chose variable-rate mortgages, down from 27% in 2023, while 69% opted for fixed-rate mortgages.

Comparing Fixed and Variable Rates

The spread between variable and fixed rates can be seen as the cost of insuring against rate increases. When rates are low and expected to stay the same or rise, locking in a fixed rate is advisable. Conversely, if rates are expected to fall, a variable rate might be more beneficial.

What Drives Fixed and Variable Mortgage Rates?

Fixed Mortgage Rates

• Follow the pattern of Canada Bond Yields plus a spread.
• Driven by economic factors like unemployment, exports, and inflation.

Variable Mortgage Rates

•  Fluctuate with the prime lending rate, which banks set for their most credit-worthy customers.
• A variable rate might be quoted as prime minus a percentage (e.g., Prime - 0.8%). So, if the prime rate is 5%, you’d pay 4.2%.

Historical Prime Lending Rates

The Bank of Canada adjusts the prime rate based on economic conditions. When inflation is high, the prime rate increases to make borrowing more expensive. When inflation is low, the prime rate decreases to encourage borrowing. The specific discount or premium on the prime rate for variable rates depends on lenders' market strategies and competition.

Understanding these dynamics can help you choose the right mortgage type for your financial situation and future expectations.