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The mortgage market is in a state of flux.
The Bank of Canada has adjusted its overnight rate twice in the last two weeks, with yet another adjustment possible soon, due to COVID-19.
The major banks have adjusted their rates accordingly, so it’s easy to see why home buyers might be confused about which mortgage is best for them — variable or fixed.
Penelope Graham, managing editor of Zoocasa, an online real estate information portal, highlights the differences between the two, starting with an explanation of the Bank of Canada’s usual reasons for lowering or increasing its overnight rate.
“The Bank of Canada assesses the state of the economy, based on a number of economic factors from unemployment and export to manufacturing, and adjusts the prime rate accordingly,” says Graham. “When inflation is high, the Bank will likely increase the prime rate to make borrowing money more expensive. Alternatively, when inflation is low, the prime rate is lowered to attract consumers to borrow money and stimulate the economy.
“Mortgage lenders set their own discounts or premiums on the prime rate, which is then applied to variable rates, based on their desired market share, competition, strategy and credit conditions. All of these factors also add to the gap between fixed mortgage rates and bond yields.”
Whether you choose a fixed or variable rate depends on your risk tolerance level.
“For the term of your mortgage, your rate and monthly payment will stay the same,” says Graham. “Fixed rates are easier to manage, as you know you’ll be paying the same amount for each payment. If there is a noticeable difference between the fixed and variable rates, the stability of a fixed rate is likely not worth the premium over a variable rate.”
“A variable mortgage rate changes with the prime lending rate, which is set by your lender,” says Graham “Variable rates are stated as “Prime-plus or minus a certain amount — as in Prime plus 1.00 percent. Although the prime rate fluctuates, the relationship to prime remains the same over the term. Variable rates have been proven to be less expensive over time. If prime increases, so does your interest payable and these fluctuations can be stressful for some home buyers.”
There are also hybrid rates, which mean borrowers have both a fixed and variable rate component.
How to choose?
“There are a number of scenarios that can help you decide between a fixed-rate and a variable-rate mortgage,” says Graham. “If interest rates are low and are unlikely to fall further, you may be best to lock in a fixed rate, as variable rates will likely increase with prime. If you’re close to your maximum affordability and could not cover an interest rate hike, you should lock in your rate for as long as possible. If you (or your broker) believe interest rates will fall, a variable rate would be a better bet, as you can reap the benefits of the lower rate during your term.”
Graham says the most popular mortgage is the fixed rate at 66 percent of mortgage holders, variable at 26 percent and combination at eight percent.
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