Ready to take that next step and become a home owner? If so, one subject matter sure to be on your mind is likely to be how you can decipher all things mortgages-related.
Particularly for those new to the the home loan process, mortgages can illicit a certain level of confusion as there are a variety of mortgage alternatives that will be more appropriate for certain home owners. Point in fact, one major question many mortgage goers encounter is how to differentiate between a variable interest rate and a fixed interest rate?
The relevance of this question however, is quite crucial to the mortgage process, as it can have a huge influence on the overall nature of a home loan, as well as how much a mortgage borrower will have to pay over time.
Before actually diving into the difference between the two types of mortgage rates, it is important to mention that each mortgage rate will come with both pros and cons. Therefore, taking a closer look and distinguishing between the two is a good place to start as you look to gain more insight into various mortgage alternatives.
What is a Variable Rate?
When opting for a mortgage with a variable interest rate, this means your loan will have an interest rate that will move in sync with the Prime Rate. A prime rate will typically move up or down, in response to a change in the Bank of Canada’s overnight lending rate.
When a lender proposes a variable rate mortgage, this means that they are offering you a rate based on the prime rate set in motion by the Bank of Canada’s rate. Sometimes, however this lender rate will vary anywhere from plus or minus 0.5% of the prime rate.
Since a variable rate can rise and fall with the movements of the prime rate, your mortgage’s interest rate is then subject to fluctuation at any given time over the course of your mortgage term.
The pros then associated with this type of rate, relate to the fact that in times when the prime rate goes down, so will your mortgage rate. As a result – you can then find yourself with the benefit of paying less interest on your loan. In kind, your total monthly mortgage payments will also decrease during that time.
The downside, however of a variable rate can mean that when the prime rate increases, so does the interest rate you have attached to your mortgage. In the scenario, you will see your monthly mortgage payments also increasing as a result.
As you can see the variable rate can have both positive and negative affects on your home loan. If, for example, you have a mortgage term of 4 or 5 years – you may be looking and many interest changes during the course of this term.
However, in times of drastic interest increases, lenders may allow their borrowers to switch over to a fixed interest rate, which we will discuss next. Alternatively, if a borrower switches and locks into a fixed rate at a time when interest rates are lower, then this is a beneficial mortgage strategy that can be used to ensure a home loan becomes more manageable.
What is a Fixed Rate?
Now a fixed rate mortgage is just as its sounds, an interest rate that remains fixed. If, for example, you enter into a mortgage term of 3, 5, or 10 years, then the interest rate you are offered at the beginning carries on, over the course of that entire mortgage term. Even in the event the prime rate changes, your rate will stay the same. Upon renewing your mortgage, only then can you look at securing a new interest rate moving forward.
In the midst of a soaring prime rate, it can certainly be very beneficial to have a rate that is unchanged. The downside however, is that you will not be able to take advantage of lower rates that may also occur during that period of time. On a positive note, some borrowers much prefer to stick with the same rate over the duration of their mortgage term, since they are better able to consistently budget their money accordingly.
On the other hand, a variable rate can be slightly lower and may decrease even more, given a lower Bank of Canada Prime Rate reduction. Therefore, as a borrower, a variable rate may appear more appealing to you in the long run.
One final note regarding the fixed rate, often times these rates will be somewhat higher than variable rates. This is one such reason that some borrowers may opt for a variable rate instead of opting for a fixed one.
In the end, there are various mortgage rate alternatives to choose from. While sometimes this can mean more decisions to make – the good news is there are more personalized options to choose from. If you have bad credit, perhaps you will also base your decision on your current financial needs, as well as what is more beneficial to you in response to a particular financial climate.