Fixed or variable rate mortgage? What a rising interest rate means for you

This past July, the Bank of Canada raised its benchmark interest rate by a full percentage point to 2.5% — the biggest jump in the bank’s rate in more than 20 years. But what does a rising interest rate mean for you? As a homeowner, how might this interest rate hike impact your finances? 

Let’s start by breaking down the pieces of a mortgage and the most common ways a mortgage can be structured, before moving into how a rising interest rate may affect your mortgage payments1

What your mortgage means. 

This much is true of any type of mortgage: in addition to repaying the principal (or the amount of money you borrowed when you took out your loan), you’ll make interest payments to the lender. The amount of interest you pay depends largely on the market and whether you opted for a fixed or variable rate mortgage.  

While influenced by the market, the best choice for you is ultimately dependent on your own unique financial situation and goals. As we’re currently in a rising interest rate environment (August 2022), it’s a good time to review your finances, consider current interest rates, and plan for your financial future. This is particularly true if your mortgage is due for renewal. Our Vancity Account Managers and Renewal Centre Specialists are available to help you make sense of changing interest rates and better understand your fixed rate versus variable rate mortgage options.  

Fixed rate mortgage. 

Think of a fixed rate mortgage as the more straightforward, predictable option. It’s controlled, keeping your interest rate the same throughout the course of your mortgage term. Even if the market shifts, your interest rate won’t — and for many people, that’s an ideal scenario. For instance, if you have a set budget or want to be able to easily track when your mortgage will be paid off, a fixed rate mortgage is a solid option that you can depend on to remain static.   

But the fixed rate mortgage is not without a potential downside: it locks you into the same interest rate until the end of your mortgage term. So, even if the market fluctuates in your favour and interest rates drastically reduce, you won’t get to reap the benefits of contributing more toward the principal value of your home, at least until your mortgage is up for renewal. You can choose to renew early, but this can result in an expensive penalty. 

Variable rate mortgage. 

That’s where the second option comes in — the one that, according to the CMHC’s bi-annual report on Canada’s mortgage industry, 53% of homebuyers and those renewing their loans chose in the last 6 months of 2021. It’s called a variable rate mortgage, and it’s a bit more complex than its fixed counterpart.  

Variable rate mortgages have a fixed term too, but depending on your financial institution, their interest rates change based on any movement of what’s called the ‘prime rate’, or the market interest rate. With a variable rate mortgage, you can still choose to pay the same amount every month throughout your mortgage term, but the amount of payment that goes toward the principal versus interest will be dependent on how the prime rate fluctuates.  

Depending on your lender, that means that if the prime rate falls, your interest rate will fall, allowing you to contribute more to the principal value of your home. But in times like these when interest rates are climbing, those in variable rate mortgages will contribute less toward the principal and more toward interest. And, without reviewing your finances, you may find yourself owing more at the end of your mortgage term than you planned.  

How a rising interest rate impacts you. 

Mortgages typically involve large outstanding balances, which means even a small change to interest rates can mean a significant difference in how much you contribute toward principal versus interest in your mortgage. 

It’s important to keep in mind that every financial situation is different and knowing what mortgage option is right for you can help you save money and gain peace of mind. It’s always a good idea to review your finances to make sure you understand your options and are prepared for any continued changes in the market.  

To better understand how a rate increase could impact your monthly budget, check out the ‘Payment’ tab in our mortgage calculator. It lets you plug in your own mortgage and adjust the interest rates to view how your payments would rise.  

The Vancity team is here to help. 

Better yet, for tailored advice that fits your finances, book an appointment with your Vancity Account Manager or Renewal Centre Specialist. We’re always here to support you, help make sense of these changes, and guide you toward a confident financial future. For any questions about fixed versus variable mortgage rates and what a rising interest rate means for you, be sure to connect with us.  

[1] The information provided in this post is based on Vancity products.

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