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Fixed vs. variable-rate mortgages: Which is right for you?

Buying a home is likely the biggest purchase you’ll ever make.

But before you can pack up and move in, you’ll need to secure a mortgage. This is often a long-term commitment. The average Canadian expects to pay off their mortgage by age 59, so it’s important to do your research and choose the option that’s best suited to you.

Basically, when it comes to the mortgage interest rate you’ll pay, you have two ways to go, fixed or variable. Which is better? Well, that depends on your risk tolerance.

To help you think through your options, we’ve outlined the differences between fixed rate and variable rate mortgages:

Fixed-rate mortgages are predictable.

With a fixed-rate mortgage, the mortgage rate and payment you make each month (or whichever frequency you choose to pay) will stay constant for the term of your mortgage.

This means you’ll know exactly how much principal (the initial amount borrowed) and interest (the amount paid on the amount you borrowed) you’ll be paying on each scheduled mortgage payment throughout the term you select.

The downside? You won’t be able to tap into a lower interest rate — ensuring more of your payments go towards the principal and less to interest — if interest rates drop during the term of your mortgage.

What a fixed-rate mortgage offers:

  • Your “set it and forget it” choice
  • Doesn’t change if the bank’s prime lending rate goes up or down
  • Eases budgeting anxiety and increases predictability

The drawbacks:

  • You may pay a premium for the stability
  • You may miss out on potential interest rate drops

Tip: Interest rates vary widely depending on the term you choose. For example, the interest rate on a 10-year fixed-rate mortgage could be almost twice as much as the interest rate on a typical 3-year fixed rate mortgage.

Variable-rate mortgages will fluctuate.

With a variable-rate mortgage, the mortgage rate will change with the bank’s prime lending rate. In this case, your scheduled payments will remain the same, but the amount paid towards your principal will vary.

Cautious buyers often choose a fixed mortgage because it means they can budget for the length of their mortgage term without any surprises. Variable rates are more unpredictable, but could work to your advantage if you can handle a bit of risk and uncertainty.

What a variable-rate mortgage offers:

  • Your “let’s see what happens” choice
  • Costs will be less if interest rates drop
  • Offers the possibility to lock in a better rate down the road

The drawbacks:

  • Works against you if interest rates rise
  • May increase your financial uncertainty

Tip: If you’re the type of person that always buys the extended warranty, then a variable rate mortgage is probably not for you.

How to choose what’s right for you

How do you feel about risk? A fixed-rate mortgage means the lender takes the risk; a variable-rate mortgage means you do. While the interest rate may be higher on a fixed-rate mortgage, it will stay constant during your term so you can budget accordingly.

How do you feel about the current market? The difference between fixed and variable rates has narrowed considerably in the last few years, making fixed-rate mortgages more appealing. Interest rates have been at historical lows, and while opinions vary, few believe interest rates won’t rise over time — the question is more likely when.

Tip: It’s really difficult to successfully time interest rates. Going variable to save money in the short run — hoping to lock in a fixed rate “at the right time” — is really tough to do.

And what if interest rates rise? No matter which route you take, it’s crucial that you evaluate the impact of an increasing interest rate on your mortgage costs — a stress test, if you will. For example, if interest rates go up by two per cent, would you still be able to afford your monthly payment? It’s important to plan for the unexpected — you can start by building an emergency fund.

Not everyone prepares for a rise in interest rates. In fact, the main reason home-buyers offer for not considering a rise in interest rates is that they simply didn’t think of it (45 per cent) or didn’t realize it was something they should be doing (27 per cent). You can do better by preparing for multiple scenarios.

The next step

BMO mortgage specialists are here to work with you to help you make the right decision based on your needs and your lifestyle.

Looking for more information? Take our mortgage calculators for a spin, or view our latest rates and special offers.

 

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Portrait of young happy couple calculating budget

Want to be mortgage-free faster?

5 tips for making a dent in your debt.

According to a BMO 2015 home-buying report, the average Canadian expects to pay off their mortgage by age 59 — but 31 per cent think they’ll still have a mortgage by their 65th birthday. Looking to ditch your debt quicker — without over-extending your budget? It may save you hundreds (if not thousands) in the long run.
The biggest benefit is saving money on interest charges. The longer it takes to pay down your mortgage, the more you’ll pay in interest. The BMO report found that, on average, Canadians believe they’ll pay approximately $60,000 in interest on their mortgage (and this number hits $100,000 for B.C. residents).

First-time homebuyer tip: Curious how mortgage payments work? It’s all about the amount of money you’re borrowing and the length of the loan. Based on these factors, your lender will calculate your payment schedule. Some of your payment will go toward interest (the amount paid on the amount you borrowed), and some will go toward your principal (the amount initially borrowed under the mortgage). You may pay more toward interest than principal in the first few years of your loan, and more toward principal in the later years. Calculate your potential payment schedule with our nifty mortgage calculator.

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Helpful tips from BMO Bank of Montreal

Take it or toss it? Six ways to decide what goes or stays before you move

Packing is a great opportunity to purge.

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Squeezing all your belongings into boxes may not be a fun way to spend your free time before you move. But, packing can provide the perfect chance to weed out any extra belongings, and start fresh.

Before you wrap up a single cereal bowl or framed photo, try the following tips to avoid moving a ton of unnecessary items into your new home. Continue reading

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Helpful Tips from BMO Bank of Montreal®

Retiring and want to relocate?

Consider these 3 pros and cons.

While nearly half of Canadian homeowners don’t plan to sell their homes when they retire, many are still unsure what they’ll do. Moving to a new city or downsizing to a more compact home can offer advantages but, depending on your goals, a few disadvantages as well. If you’re thinking about a post-retirement move, consider these pros and cons before you start packing:

When you relocate to a new city or property…

  • PRO: Save money on daily expenses: If you relocate to a less expensive area, you’ll be able to stretch your retirement savings further. Consider the benefits of a suburb vs. city, and look to exotic areas that provide a lower cost of living. Need a little inspiration? Mexico, Panama, and Costa Rica are popular post-retirement spots for Canadians. Or, look to Buenos Aires, Argentina, where you can rent a one-bedroom apartment (in a good area!) for as little as $400 a month.
  • CON: Spend money on moving costs: Even if you’re exchanging your current digs for a less expensive property, moving isn’t cheap — real estate agent expenses, land transfer tax and moving costs can dissolve a big chunk of money. In Toronto, for example, land transfer costs, legal fees and moving expenses alone could be $15,000 or more. Plus, you’ll have to consider the cost of traveling to visit family, but if you pick a tropical locale, Canadian relatives may be more likely to come to you.

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Helpful Tips of the Month from BMO

Five fun ways to help your preschooler learn about money.

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It’s never too early to help them make sense of money.

If your kids can count, they can start learning about money. At this young age, a great way to teach them is through multisensory experiences that include lots of play, songs, and arts and crafts. Here are five fun ways you can engage your little one in lessons about dollars and cents: Continue reading