Fixed, Variable or Adjustable: How Each Mortgage Rate Type Works
When you set up a mortgage, the rate type is one of the first decisions. Fixed, variable and adjustable all sound similar, but they behave differently in two places: what happens to your payment when rates move, and what it costs if you break the mortgage early.
Not every lender offers all three, and the details differ from one lender to the next. Here’s how each one works.
Fixed rate mortgages
With a fixed rate, your interest rate and your payment stay the same for the whole term. Nothing about the mortgage changes if rates move up or down along the way.
Fixed rates follow Government of Canada bond yields, plus the lender’s margin. That is why fixed rates can move even when the Bank of Canada hasn’t changed its rate.
If you break early: the penalty is the greater of three months’ interest or the interest rate differential (IRD). The IRD is roughly the interest the lender gives up when it has to lend your money out at a lower rate for the rest of your term, so it matters when rates have fallen since you signed.
How the IRD is calculated also varies. Banks often calculate it using their posted rate, while monolines often use your contract rate. Two lenders can charge very different penalties on the same mortgage, so ask how it’s calculated before you choose a lender.
Variable rate mortgages
With a variable rate, your payment stays the same, but your rate moves with prime. Prime moves with the Bank of Canada’s rate decisions.
Because the payment doesn’t change, the split between principal and interest does. When the rate goes up, more of each payment goes to interest and less to principal, which can stretch your amortization. When the rate goes down, more goes to principal, which can shorten it.
If you break early: the penalty is typically three months’ interest.
Adjustable rate mortgages
An adjustable rate also moves with prime, but it works the other way around. Your payment changes each time the rate changes, and your amortization stays the same.
The difference from a variable rate is where the change shows up. With a variable rate, the payment stays put and the amortization moves. With an adjustable rate, the amortization stays put and the payment moves.
If you break early: the penalty is typically three months’ interest.
The three side by side
| Fixed | Variable | Adjustable | |
|---|---|---|---|
| Rate follows | Government of Canada bond yields, plus the lender’s margin | Prime | Prime |
| Your payment | Stays the same | Stays the same | Changes when the rate changes |
| Your amortization | Stays the same | Can stretch or shorten | Stays the same |
| If you break early | Greater of three months’ interest or the IRD | Typically three months’ interest | Typically three months’ interest |
Which one fits
It depends on your budget and how much change in your payment you’re comfortable with. A fixed payment is predictable. A payment that can change needs room in the budget for it to go up.
The penalty is part of the decision too. If there’s a reasonable chance you’ll move, refinance or sell before the term ends, what it costs to break matters as much as the rate. A fixed rate’s penalty can be much larger than three months’ interest, depending on the lender and how rates have moved.
Rates and lender policies change often, so I haven’t listed any rates here. If you’d like to talk through which type fits your situation, connect with me at 249-480-1249 and let’s look at it together.
This is one of the 10 things I cover in my monthly live session, Before You Buy: 10 Things Every Homebuyer Needs to Know. Save your spot here.
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HumberBayMortgages.ca
Simon Browning | Mortgage Agent Level 2 | BRX Mortgage 13463
This content is for informational purposes only and does not constitute financial advice. Rates and market conditions change frequently. Always consult a licensed mortgage professional before making decisions about your mortgage.