“Fixed or variable?”
Whether you’re a homeowner already or you’re in the market for a home, you’ve probably heard this question. And if you’re not sure what it means, you’re certainly not alone.
Basically, the “fixed or variable” question refers to the type of interest rate you’ve chosen for your mortgage. A variable rate mortgage can often seem like the best choice for mortgage holders, but it’s also a little more complicated — especially in a rising interest rate environment.
Today, we’re unpacking what it means to have a variable rate mortgage: whether you have a variable rate mortgage now, are preparing for renewal, or are looking to enter the market, here are 5 things to know as interest rates climb1.
What a variable rate mortgage means.
Before we get into the impact of rising interest rates on variable rate mortgages, let’s define the parts of a mortgage and determine what a variable rate mortgage actually means.
No matter the type of mortgage you choose, each payment you make will break down into two parts: the principal and interest. Principal refers to the amount of money you borrowed to pay for your home purchase, while interest is the amount of money you’ll pay to the lender.
There are two factors that determine how much interest you’ll pay: the overall market, and your answer to the “fixed or variable” question.
While the market isn’t something that we can control or often predict, it’s up to the homeowner to decide whether a fixed or variable rate mortgage is right for them. Booking an appointment with a Vancity Account Manager or Renewal Centre Specialist can help them make sense of their options and make a choice that matches their financial situation and goals.
Here’s a quick breakdown of fixed versus variable rate mortgages:
If you go for a 5-year fixed rate mortgage, the amount of interest you pay will be static and unmoving throughout those 5 years. It’s a very predictable option for what can be a hard-to-predict market.
But if you choose a 5-year variable rate mortgage instead, your interest rate will vary based on what’s called the ‘prime rate’, or the market interest rate, throughout your mortgage term. It can be a great choice or a troublesome one, depending on your unique financial situation, your goals for the future, and the state of the market overall.
For a full breakdown of fixed versus variable rate mortgages, check out our recent blog post; it goes into detail on what a rising interest rate means for you, depending on the type of mortgage you have.
A variable rate mortgage is a bit riskier.
A variable rate mortgage carries more risk than a fixed rate mortgage since it’s tied to the prime rate. When the prime rate decreases, for example, variable rates also decrease – making a variable rate mortgage a potentially attractive option in a consistently low-rate market environment. On top of that, variable rates tend to be lower than fixed rates overall, which only adds to their appeal.
Sounds good, right? So, where’s the risk?
Naturally, the prime rate isn’t always low. And when the prime rate rises, variable rates can rise too. We’re seeing this a lot this year, and as of September 2022, the Bank of Canada has raised its benchmark interest rate to 3.25%. As interest rates climb, different challenges can arise for different people, depending on their financial circumstances and goals.
Same payments, different interest.
As we’ve seen in 2022, the prime rate can increase dramatically in a short period of time. And in an environment like this, even if someone’s variable rate mortgage payments are staying the same, their interest rate can change significantly throughout their mortgage term.
For instance, let’s say Van – a variable rate mortgage holder – has heard chatter about the Bank of Canada’s recent interest rate announcement, but he doesn’t fully understand what ‘rising interest rates’ mean or how they affect him. Besides, his mortgage payments are the same as they’ve always been – so why worry about it?
What Van should know is that, even though his mortgage payments are staying the same, he’s paying less towards the principal and more towards interest with every payment – meaning it may take him more time to pay off his mortgage in full.
Variable rate mortgages can be impacted by ‘trigger rates’.
Like Van, variable rate mortgage holders can have fixed payments, meaning their payments stay the same, even as their interest rate fluctuates. This is until the interest rate level hits what’s known as a ‘trigger rate’.
Trigger rates exist to make sure homeowners are always building equity with their mortgage payments. But trigger rates can also sneak up on variable rate mortgage holders, causing a great deal of stress and uncertainty.
For instance, let’s say Van hits his trigger rate. That means that the prime rate has increased to the point where Van’s fixed payment is no longer enough to cover the interest he owes. At this point, Van’s lender can increase his fixed payment on his variable rate mortgage to help him cover the new level of interest.
No matter your mortgage, we’re here to help.
Whether your mortgage is up for renewal, or you have questions about how rising interest rates may affect your variable rate mortgage, the 5th thing we want you to know is that our Vancity team is here to support you.
A rising interest rate environment can be a stressful time for us all in different ways. For tailored advice that fits your finances, book an appointment with your Vancity Account Manager or Renewal Centre Specialist today. We’re always here to support you, help make sense of these changes, and guide you toward a confident financial future.
1The information provided in this post is based on Vancity products.
Want to learn more about the rising interest rate environment and what it means for you? Check out our Instagram Live Q&A with Vancity’s Ryan Mckinley (Sr. Mortgage Development Manager) and Stephanie Larbalestier (Account Manager).