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An open 5-year variable has some key similarities and differences versus the more popular closed 5-year closed mortgage.
On the one hand, both are variable, or “floating-rate” mortgages, meaning the interest costs can fluctuate over the term if prime rate rises or falls. Unless you have a fixed-payment variable rate (usually just called a variable-rate mortgage, or VRM), these movements in prime could affect your monthly mortgage payments (that’s referred to as an adjustable-rate mortgage, or ARM).
In the case of a VRM, if prime rate rose, the amount of your monthly payment going towards interest cost would increase and the amount going towards principal would decrease, and vice versa if prime rate fell.
The thing that makes open variable mortgages unique is that they allow the borrower to repay as much of the loan as they like -- at any time without penalty. That said, the loan is still based on scheduled payments over the five-year term.
Closed mortgages, on the other hand, have restrictions on the amount you can repay on top of your scheduled mortgage payments.
Breaking a closed variable mortgage early can also entail prepayment charges. Those “penalties,” as it were, are typically three months’ interest.
If you’re debating whether a 5-year variable-rate open mortgage is for you, here are some advantages to consider.
Open variables have some disadvantages as well.
The significant rate premium means you should never plan to hold an open variable for more than 3-9 months. Any more than that and you’d potentially be better off getting a low-cost closed variable, breaking the mortgage early and paying the 3-month interest charge.
Learn more about 5-year variable mortgages.
As of this writing, in spring 2021, prime rate has remained unchanged at 2.45% since March 2020. Guidance from the Bank of Canada suggests no changes to its target overnight rate until mid-to-late 2022.
Those tempted by low floating-rate offers can have confidence that rate hikes are not on the horizon for at least the next year and a half, says the Bank of Canada. However, borrowers should be mindful that the most likely direction for rates is upwards, so be prepared to:
(A) see your rate rise in the coming years, or
(B) lock into a fixed rate at the first sign that rates will rise.
Note: There is little chance of obtaining the best fixed rates available when you are switching from a variable to a fixed. Among other reasons, that’s because lenders anticipate rising rates well ahead of most borrowers and price their fixed-rate offers accordingly.
If the flexibility of being able to repay your mortgage at any time is important to you, another option is a Home Equity Line of Credit (HELOC).
A HELOC lets you borrow against your home equity. HELOC interest rates fluctuate because they are quoted as a discount or premium to the prime rate. Borrowers can repay their HELOC as quickly or slowly as they want, as only the interest cost must be paid each month.
HELOCs have cheaper rates but often higher set-up costs. Moreover, you cannot transfer a mortgage into a HELOC so legal fees generally apply. Some lenders do allow free transfers into an open variable mortgage.
Find out if a HELOC is right for you.