Variable vs Fixed mortgage rates are a common topic of discussion as interest rates begin to decline, prompting many homebuyers and homeowners to revisit the debate. For some, variable rates have been a valuable tool for paying off their mortgage faster, since the initial rate is often lower than fixed-rate mortgages. However, recent years have demonstrated how risky variable rates can be. Many faced the harsh reality of rapid rate hikes, far beyond the gradual increases seen over the previous decade.
While variable rates can offer potential savings, it’s essential to understand the risks before diving in. If you tend to avoid risk or if fluctuating rates make you anxious, then a variable rate may not be the best option. The key to making a sound decision lies in understanding how the variable rate works and the broader financial trends.
VRM vs. ARM: Understanding Variable Rate Mortgage Options
There are two main types of variable-rate mortgages: VRM (Variable Rate Mortgage) and ARM (Adjustable Rate Mortgage). It’s crucial to understand which one you currently have or will be getting, as the terms and implications can differ.
Variable Rate Mortgage (VRM): With a VRM, your interest rate changes in line with the prime rate, but your monthly payments often remain the same. However, as the interest rate increases, more of your payment goes toward paying the interest rather than reducing the principal. If the interest rate drops, more of your payment goes toward the principal. VRMs are attractive because you don’t have to worry about sudden changes in your monthly budget, but your progress in paying down the mortgage principal could slow if rates rise.
Adjustable Rate Mortgage (ARM): With an ARM, your interest rate fluctuates with the prime rate, but both your interest rate and monthly payment will adjust. If rates increase, your payments will go up, and if rates decrease, your payments will go down. ARMs are more sensitive to rate changes than VRMs, potentially leading to immediate financial pressure if rates rise.
Understanding the difference between VRM and ARM is essential because each type of mortgage handles rate fluctuations differently. One may be better suited to your financial needs and risk tolerance.
How Variable vs Fixed Mortgage Rates Are Determined
A variable mortgage rate moves in response to the prime rate, which is influenced by the Bank of Canada’s decisions. The Bank of Canada typically meets about eight times a year to determine whether to increase, decrease, or hold the prime rate steady. If the prime rate goes up, your variable rate will rise accordingly, and so will your mortgage payments (unless your lender offers a fixed-payment variable mortgage). Conversely, when the prime rate decreases, homeowners with variable-rate mortgages will see their payments reduced, potentially allowing them to pay off their mortgage faster.
A key advantage of the variable rate is that it usually starts lower than the fixed rate. However, there is always the risk that it may rise unexpectedly, as many homeowners experienced when rates surged recently.
Locking into a Fixed Rate: Navigating the Variable vs Fixed Mortgage Decision
If you choose a variable rate but notice a trend of increasing rates, you typically have the option to switch to a fixed rate. This can be a helpful safety net if you feel uncomfortable with rising rates. Many homeowners made this choice in recent years as rates climbed. However, others decided to ride out the increases, hoping that rates would drop again soon. This decision can be a gamble, and it’s essential to weigh your risk tolerance and financial stability.
Pros and Cons of Variable vs Fixed Mortgage Rates
Pros:
- Potential for lower payments: If rates stay low, you can enjoy lower monthly payments and pay off your mortgage more quickly.
- Flexibility: You can often lock into a fixed rate if you see rates trending upward, giving you some control over the risk.
Cons:
- Uncertainty: Rates can rise unexpectedly, increasing your monthly payments and overall mortgage costs.
- Financial stress: If you are not comfortable with fluctuations, the variable rate can cause anxiety, especially in uncertain economic times.
Remaining Bank of Canada Meetings for 2024 and Their Impact on Variable vs Fixed Mortgage Rates
October 23, 2024
December 11, 2024
By staying informed and consulting with a mortgage broker, you can make the best choice for your home purchase or refinancing needs. Whether you opt for a variable or fixed rate, understanding the pros and cons is key to making a decision that aligns with your financial goals.
Book an Appointment to Explore Your Variable vs Fixed Mortgage Options
If you have any questions or want to explore your options further, feel free to book an appointment at www.rtsmortgagefinancial.com.