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A question that haunts many homebuyers is whether they should go for a variable or fixed-rate mortgage. If you are one such homebuyer, then continue reading as this guide is for you.
It mainly depends on your financial circumstances as to what option you should take. So, we will see the differences between the two and how to choose between them.
What Is A Fixed-Rate Mortgage?
A fixed-rate mortgage as the name suggests is a mortgage when your payment amounts do not change over the length of the loan term. Your payments go toward paying off the principal and interest combined. Although the payment remains the same each month, the percentage of each payment that goes toward paying off the principal and interest varies with each payment as you pay down your mortgage.
The two mortgages have an inverse relationship, where the interest paid will slowly decrease as the principal paid will increase.
How Is A Fixed-Rate Determined?
Fixed mortgage rates are set by the prime rate and the state of the economy at the time your loan contract is signed. As a result, regardless of how the economy and prime rate perform a few years later, the interest rate during your term will always be the same.
Banks and lenders generally set their rates based on the Bank of Canada’s benchmark rate. The benchmark rate is a rate that banks and lenders must use when determining whether or not a borrower is qualified for a mortgage in Canada. The rationale for this is that the government wants to ensure that people can cope with market volatility. As a result, you’ll generally discover that the benchmark rate is around 1.5 per cent higher than the market’s best rates.
Advantages And Disadvantages Of A Fixed-Rate Mortgage
Even if the cost of a fixed-rate mortgage is slightly higher than a variable-rate mortgage, there are still several advantages.
There is no risk because any increase in interest will have no effect on you. You’ll make the same payments every month, regardless of what influences the economy and hence the rate. A fixed-rate is appropriate for you if you have to stick to a strict budget and don’t have the financial security or flexibility to make variable payments.
While a fixed rate is less risky, it can be more costly in terms of interest. Higher interest rates can make payments more difficult to afford. When this happens, borrowers may choose to prolong the term length to make payments more reasonable, resulting in additional interest paid during the period.
What Is A Variable Rate Mortgage?
A variable rate mortgage varies and changes with the prime rate. When the prime rate is adjusted based on economic factors the rate on your mortgage is adjusted as well. Therefore, your payments can be constantly changing based on economic factors.
How The Variable Rate Mortgage is Determined?
The variable rate is calculated using Canada’s prime rate. It varies with the prime rate, and it will vary whenever the prime rate changes. The prime rate is a benchmark interest rate used by large banks and financial organisations to set rates for various lending products.
It is impacted by the Bank of Canada’s overnight rate, which is moulded by the cost of borrowing for Canada’s main financial institutions. Rates are sometimes marketed as 3.95 per cent with prime – 1.20 per cent written beneath it. The prime rate (5.15%) minus the discount rate (1.20%) equals your interest rate (3.95 per cent).
Advantages And Disadvantages Of A Variable Mortgage Rate?
If you opt for a variable rate instead of a fixed rate, you’ll save more money depending on what happens with the central bank’s prime rate. This is due to the fact that as the prime rate falls, so does the interest rate on your mortgage. When prime rates fall, so does the variable rate, allowing more money to be put toward principal repayment. The more money you put into the principal, the less interest you’ll pay and the sooner you’ll be able to pay off your mortgage.
However, if the prime rate rises, your mortgage interest rate will rise as well. People who choose variable-rate mortgages must be financially stable in order to manage this risk. A variable rate mortgage may be suitable for you if you do not need to stick to a strict budget.
Which Rate Should I Choose?
When deciding between a variable and fixed-rate mortgage, you must weigh a variety of personal and financial considerations to determine which option is best for you. Locking in a fixed rate is recommended if interest rates are relatively low and you do not expect them to fall more throughout your loan term. A variable rate, on the other hand, maybe better if you predict rates to fall. However, keep in mind that no one can anticipate how mortgage rates will vary over time with 100 per cent accuracy, so be sceptical of the information you receive.
You must also evaluate your own financial status in addition to economic issues. Is it possible for you to afford a sudden increase in payments if interest rates rise? If not, the security of a fixed rate will be more appropriate. If you can keep up with rapid changes, though, a variable rate may be worth it for the potential interest savings.
The Bottom Line
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