After picking between an open or closed term of mortgage, the next question that you are faced with is to pick between a fixed or variable rate. Choosing the mortgage term is dependent on a number of factors including your current and probable financial situation, risk tolerance capability etc. To choose your term carefully you should know a few things.
What is a fixed-rate mortgage? What are its advantages and disadvantages?
A Fixed-rate mortgage is one when your monthly mortgage payment and your rate remains the same all along the mortgage term at a price it was fixed when taking up the mortgage. When your mortgage term ends, you would have to renew the mortgage on a new agreed rate and a new term, and sometimes from a different lender than the original one.
The advantage of taking a Fixed-rate mortgage is that the rate remains unchanged throughout the term of your mortgage. This leads to same payments throughout the mortgage term which is easier on your budget. However, if the prime mortgage rate goes down, then your probable savings are missed out as your mortgage rate doesn't go down and remains same.
What is a variable-rate mortgage? What are its advantages and disadvantages?
A variable-rate mortgage, unlike the fixed-rate one, is a mortgage in which the rate differs as per the market price and is related to the prime rate or standard rate of the lender. So if there is a change in the prime rate, you rate will remain the same in relation to the prime rate. Your rate will drop if prime rate drops and increase if the prime rate goes up, and hence, your monthly payments get altered accordingly.
The advantage of a variable-rate mortgage is that in case of a drop in the prime rate, your mortgage rate goes down and hence you benefit. Variable Rate, has, in general, shown to be of benefit (savings) in the course of time. There is always the risk of financial loss and uncertainty when the rates go up as do your monthly payments.
When do variations in mortgage rates arise?
Mortgage rates change with changes in the overnight rate of the Bank of Canada. So when the prime rate is hiked, it may lead to a hike in rates of mortgage. In the case of such a hike, those who have fixed-rate mortgages don't feel the impact till they reach the end of their term but those holding a variable-rate mortgage feel the impact instantly.
Conclusion
A hike in the prime rate isn't always bad news for variable-rate mortgage holders unless their initial loan exceeds your budget. When the rates are low some get tempted to buy beyond their financial limits, and when the rates are hiked later on, they end up in sticky financial situation. Thus, respect your financial situation and factor in your risk-tolerance while making a decision about which rate to opt for. And finally, ensure you shop around for good deals before signing up.
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