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Fixed and Variable Mortgage Rates - Mortgage Math #4 with Ratehub.ca

When you're ready for a mortgage, you'll have to decide whether to go variable or fixed.

With a fixed rate mortgage, your interest rate and monthly payment will stay the same

across your term. With a variable rate on the other hand, your interest rate and monthly

payments are likely to fluctuate over the course of your term. We've brought in mortgage

broker Ian MacKay to walk you through both types of rates and show you the differences

in more detail.

As Alyssa mentioned, your variable rate mortgage will start with a lender's prime rate. The

lender will either offer you a premium or a discount to their prime rate.

In this illustration, your lender has offered you a variable rate mortgage at a discount

of Prime minus point-four-five per cent. With the current prime rate of three percent, your

effective interest rate for your variable rate mortgage is two-point-five-five per cent.

If the prime rate were to increase to four per cent, your effective interest rate would

be three-point-five-five percent. And if prime rate increased to five percent, your effective

interest rate would be four-point-five-five per cent.

Important points to consider are that your relationship with Prime never changes throughout

the term, and that Prime can change based upon the bank's overnight lending rate.

Let's say you just purchased a home for three-hundred-thousand, and have a five per cent down payment. In

this example, with a five year fixed interest rate of two point nine per cent you would

have a monthly mortgage payment of one-thousand-three-hundred-seventy-five-dollars. With a variable rate mortgage, with an effective

interest rate of two-point-five-five per cent, you would have a monthly mortgage payment

of one-thousand-three-hundred-nineteen-dollars. In this example, the variable rate mortgage

payment is less; however you must consider that your payment can fluctuate throughout

the length of the term. Two years into your term, Prime has increased

to four per cent. What that means is the effective interest rate of your variable rate mortgage

has increased to three-point-five-five per cent. That also means that your effective

monthly mortgage payment has increased to one-thousand-four-hundred-seventy dollars.

Now, let's look at how much these interest rates would cost you over a five-year term

since fixed interest rates remain the same over five years we simply multiply the payment

over sixteen months. That would give you an effective mortgage payment over five years

of eighty-two thousand-five-hundred-dollars. For the variable rate, we must take the payments

for the first two years when the rate was two-point-five-five per cent and then calculate

the payments for the last three years when the rate was three-point-five-five per cent.

The payment for the first two years is thirty-one-thousand-six-hundred-fifty-six-dollars, and the payment for the last three years was

fifty-two-thousand-nine-hundred-twenty dollars, for a total of eighty-four-thousand-five-hundred-seventy-six

dollars. In this example, payments for the five-year

fixed are lower than the five-year variable rate. However, that is not always the case.

For the sixty per cent of Canadians that prefer the stability of a fixed interest rate, variable

rate interest rates have been lower over the past ten years.

A fixed-rate provides stability and eases budgeting anxiety because it is constant over

the creation of the term. However, when the fixed rate is significantly higher, the stability

is often not worth the premium.