When you’re considering fixed vs. variable rate mortgages while in the market for a new property, refinancing, or renewing your existing mortgage, one critical decision is whether to opt for a fixed or variable rate mortgage. This choice is entirely up to you, and we’re here to provide you with valuable information to help you decide.
Fixed-Rate Mortgage: Stability You Can Count On
First, let’s delve into the fixed-rate mortgage, the option most commonly recommended by banks. With a fixed-rate mortgage, the interest rate remains constant for a specific term, typically ranging from 6 months to 10 years, with the standard term being five years. Regardless of any market fluctuations after you’ve signed the agreement, your mortgage rate remains unchanged. It’s as sturdy as a rock, although it usually comes with a higher rate compared to variable options.
Variable Rate Mortgage: Market-Linked Flexibility
On the other hand, a variable rate mortgage doesn’t offer the same stability. Instead, it fluctuates in tandem with market changes. The variable rate is linked to the prime rate, which can either add to or subtract from it. For instance, if the prime rate is 2.45% (determined by the government and banks) and the current variable rate is Prime minus 0.45%, your effective rate would be 2%. Should the prime rate increase by 0.25% three months after signing your mortgage documents, your rate would adjust to 2.25%. Variable rates usually come with a five-year term, although some lenders offer shorter terms.
Penalty Considerations: Fixed vs. Variable
At first glance, the choice between Fixed vs. Variable Rate Mortgages makes the fixed-rate mortgage appear to be the safer choice, while the variable-rate mortgage may seem more unpredictable. However, the issue with this perspective is that it overlooks the distinct methods used to calculate the penalty for breaking your mortgage under these two options.
Breaking Down Penalties: Fixed-Rate vs. Variable-Rate
If you decide to break your variable rate mortgage, you’ll owe only three months’ interest, regardless of the remaining term. This amounts to roughly two to two and a half payments, a straightforward calculation that’s not too burdensome.
In contrast, a fixed-rate mortgage will entail the greater of either three months’ interest or an interest rate differential (IRD) penalty. Every lender computes their IRD penalty differently, factoring in market variations, the contract rate at the time of signing, the discount applied at that time, and the remaining term. As a result, predicting the penalty proves challenging, and should you end up facing an IRD penalty, it won’t be a pleasant experience.
Making the Right Choice
If you’ve heard stories about banks imposing exorbitant penalties for breaking a mortgage, those instances typically involve the application of an interest rate differential. It’s not uncommon to see penalties for fixed-rate mortgages that are 10 times higher than those for variable-rate mortgages, sometimes reaching up to 4.5% of the outstanding mortgage balance.
So, let’s make a straightforward comparison:
- A fixed-rate mortgage initially requires higher payments than a variable-rate mortgage but maintains stability throughout the term. The penalty for breaking a fixed-rate mortgage is unpredictable and can reach up to 4.5% of the outstanding mortgage balance.
- A variable-rate mortgage has lower initial payments than a fixed-rate mortgage but follows market fluctuations throughout the term. The penalty for breaking a variable-rate mortgage is predictable at three months’ interest, equivalent to roughly two and a half payments.
Choose Wisely
The primary goal when securing a mortgage is to minimize the total cost of borrowing. This involves reducing your overall expenses. While a fixed-rate mortgage offers stable payments, the variable rate is better suited to adapt when life takes unexpected turns.
If you have any questions feel free to reach out anytime. We’re here to help you navigate your real estate goals.
Contributed by Sabeena Bubber – reach out to Sabeena for more mortgage info here.