A variable, or “floating,” rate mortgage has an interest rate that fluctuates with your lender’s prime rate.
Banks and other mortgage lenders base their prime rate on the Bank of Canada’s target overnight rate, or “policy interest rate.” When the Bank of Canada adjusts this rate, it almost always results in a change to each lender’s prime rate. That in turn impacts borrowers’ variable rates, and their monthly payments. When monthly payments change with prime rate, it’s called an adjustable-rate mortgage (ARM).
However, if you have a fixed-payment variable rate, the monthly payment will remain constant even if your mortgage rate fluctuates. For example, if interest rates were to fall, the amount of your payment going towards principal reduction would increase while the interest portion would decrease. Similarly, if rates were to increase, more of your payment would go towards the interest.
Variable rates are typically in highest demand when the prime rate is expected to drop (e.g., entering a recession), and when the difference between fixed and variable rates is over one percentage point.
One advantage of having a variable-rate mortgage is that prepayment penalties are typically limited to just three months' interest should you need to break your mortgage early. The penalties on fixed-rate mortgages, on the other hand, are calculated using the greater of three months’ interest or the Interest Rate Differential (IRD). IRD can end up costing some borrowers five figures to break their mortgage.
Floating-rate mortgages also give you an option to “lock in” to a fixed rate at any time during your mortgage term. This is useful if you expect mortgage rates to rise and want to secure a rate for the remainder of your term.
Pro Tip: You can calculate your mortgage payments based on different interest rate scenarios using our Mortgage Payment Calculator.
Learn more here about fixed vs. variable-rate mortgages.
Like fixed rates, there are two types of floating-rate mortgages: closed and open.
Closed variable mortgage: A closed mortgage involves a regular repayment schedule that typically only allows limited prepayment options. Lenders commonly allow you to make extra payments of 5% to 30% of the original loan amount in any given year. Many also allow increases to your monthly mortgage payments by similar amounts.
Open variable mortgage: Just like a closed mortgage, there is a regular payment schedule set out for the borrower. The difference is, an “open” involves more flexible options to pay down the mortgage. Those with an open term can increase their regular payments or make lump-sum prepayments of any amount (including the entire loan amount) and at any time without penalty. Open variable mortgage rates are typically at least 1.50 percentage points higher than closed mortgages due to this flexibility. You’re often better getting a deep-discount home equity line of credit (HELOC) at a much cheaper floating rate than an open variable.
Here’s a rundown of the most common variable-rate mortgage terms…
1-year variable: Few borrowers choose a 1-year variable rate. Because they’re so rare, they typically entail a premium that make them a notably more expensive choice compared to the 3- and 5-year variables. Most borrowers would be better off choosing a 1-year fixed rate, although 1-year variables entail a lower prepayment penalty and can be converted to a fixed rate at any time.
3-year variable: A 3-year variable-rate mortgage is a great option for homebuyers who are looking for a variable interest rate with a short-term commitment, particularly if there is a chance you may need to sell your home or re-negotiate your mortgage in the not-too-distant future. The rates are usually higher than 5-year variables, however.
5-year variable: After the 5-year fixed, a 5-year variable is the second-most popular mortgage term in Canada. In 2019, about one out of five mortgagors took out a variable rate, according to data from Mortgage Professionals Canada. They’re ideal for those who want a standard 5-year term, but who think rates will remain low. They may also be suitable if there’s a good a chance you’ll need to break the mortgage before maturity (given their lower prepayment penalties).
Fixed and variable rates each come with their own pluses and minuses. Here are some pertaining to variable rates…
Pro Tip: This isn’t always true. Some “low-frills” mortgages have much higher penalties than just three months’ interest. Some, for example, charge you 3% of principal for breaking the contract.
Here’s everything you must be wondering about variable-rate mortgages.
Choosing the best mortgage for you depends on your mortgage affordability. When you choose a fixed-rate mortgage, your monthly mortgage payments will stay the same for the term of your mortgage, allowing you to predict your mortgage costs during the mortgage term and budget accordingly. Fixed-rate mortgages are generally higher than variable-rate mortgages.
When you have a variable rate mortgage, your mortgage rate will change with the prime lending rate set by your lender. If the interest rate decreases multiple times during the course of your mortgage term, you can pay off your mortgage principal faster. A variable-rate mortgage also means that the amount that goes to your mortgage principal will fluctuate when the rate increases or decreases, even though your mortgage payment amounts remain the same. This means that you’ll face surprises during your mortgage term, as the rates won’t be stable or constant.
You can calculate your Mortgage Affordability to see what kind of mortgage scenarios work for you. A Mortgage Payment Calculator can help you see what your future mortgage payments will look like.
When it comes to picking a mortgage, comparing multiple quotes can help you find the perfect fit. Compare the best mortgage rates on RATESDOTCA today.
If you have a variable-rate mortgage, your interest rate can vary throughout the term. This makes it important for you to lock-in a favorable interest rate if you are allowed to do so by your lender. Locking the interest rate guarantees a certain interest rate for a specific period, normally between 30 and 60 days.
Most lenders allow you to lock your interest rate as soon as your initial loan is approved. Some lenders may charge a fee to lock in your interest rate. Always ask questions so you know what charges to expect from your lender. Make sure you consult with an experienced mortgage broker and read your mortgage terms and conditions thoroughly.
As a first-time homebuyer you must be wondering where does your whole monthly mortgage payment go! Your monthly mortgage payment goes toward the following costs:
If you want to pay more towards your principal amount, check the prepayment options in your mortgage contract to pay off your principal faster.
Engaging a mortgage broker before renewing can help you make a better decision. Mortgage brokers are an excellent source of information for deals specific to your area, contract terms, and their services require no out-of-pocket fees if you are well qualified.
Here at RATESDOTCA, we compare rates from the best Canadian mortgage brokers, major banks and dozens of smaller competitors.