What type of mortgage and term should you get?

Buying a home is probably the biggest purchase you’ll ever make. Along with the massive decision of choosing the right property, you also have to think about what kind of mortgage you should sign.

Currently, interest rates are high (well, higher than the super-low rates we’ve become accustomed to over the last 20 years), and you might wonder how that impacts the decision on the type of mortgage you should get and term length. Whether you’re debating between a fixed or variable mortgage, a three-year term or five (or even one!), we’re here to help you make an informed choice.

Variable vs. fixed rate mortgages

Fixed-rate mortgages are just that – Fixed. They offer a consistent interest rate over the length of the term. The bond market determines these fixed rates: When the bond yield decreases, fixed mortgage rates also decrease. Over the past year, bond yields have trended slightly upward, which, unfortunately means higher rates for anyone looking to sign a fixed mortgage.

Fixed rate mortgages are appealing because your payments won’t fluctuate. You’ll know exactly what your payment will be each month until the end of your term, which helps with budgeting and financial planning. However, historically, banks' fixed rates have been higher than the variable rates.

On the other hand, variable rate mortgages follow the prime rate set by the Bank of Canada (BoC).

Variable rate mortgages fall under the two following camps:

• Fixed-payment variable: Your monthly mortgage payments remain steady, but the time you have to pay off the entire mortgage (also known as the amortization period) will increase or decrease based on the current BoC interest rates.
• Floating variable rate: Your monthly mortgage payments fluctuate directly with the changing interest rate environment.

Starting in 2022, the BOC’s series of rate hikes increased the overnight rate to 5%, making much higher monthly payments for some variable rate mortgage holders.

However, according to many experts, we may be at the top of the rate cycle, meaning variable mortgage rates will only decrease from here.

Related: $23,579: This is how much more a variable-rate could have cost homeowners over fixed-rate

Should you opt for a variable rate mortgage?

If you’re considering a variable rate mortgage now, you’re probably counting on the upcoming rate decrease and don’t want to lock yourself into the higher fixed rates offered.

However, the risk is that if the rates stay steady or take a while to fall, you may be stuck with a higher monthly payment than you anticipated.

“The danger element has been reduced because it's unlikely for there to be an increase, but the timing of the decreases is unknown. You're just guessing,” explains Ron Butler, a mortgage expert and founder of Toronto-based Butler Mortgage. “And when it starts to go down, it does not traditionally/historically ever go down quickly.”

Read more: How interest rate changes affect your variable rate mortgage

How to choose a mortgage term

Mortgage terms can range from as short as a few months to more than five years. Generally, the shorter the term, the lower the interest rate, although this isn’t a hard and fast rule.

So, how do you decide how long your term should be? It totally depends on a combination of your financial situation, your tolerance for uncertainty, and the current market.

In a market where interest rates are low, like we saw in 2020 and 2021, it made sense for people to opt for longer fixed-mortgage terms. However, with interests remaining high, that calculus has changed.

A shorter-term variable mortgage may allow you to capture a falling interest rate and sign up for a lower-rate mortgage when it comes time to renew. The penalty for getting out of a variable rate mortgage is often low, and you can easily convert to a fixed rate mortgage.

Another option is to choose a one-year fixed term mortgage and then convert it to a longer term later.

“If a customer decided to take a one-year fixed today a year from now the balance of probability is that they would be able to get a lower five-year fixed or a lower three-year fixed than where the variable rate would be," Butler predicts. “You can make a compelling case that a borrower today should take a one-year fixed rate mortgage.”

As you can see, there are a lot of factors to consider before you decide on the type of mortgage and length of term. Whatever you choose, stay informed, crunch the numbers and compare mortgage rates to ensure you can cover the monthly payments and meet the conditions for the mortgage stress test.