What are fixed fee and variable fee mortgages?

Mortgages don’t have to be complicated. By breaking down everything you need to know into smaller pieces, you can learn a lot about mortgages in a relatively short amount of time. Even if you are working with a broker, it’s good to know the differences between your options so that you can make a more informed decision.

The amount of money that you’ll end up paying in interest fees throughout the life of your mortgage is influenced by a handful of factors. This includes the initial size of the mortgage, your interest rate, and the type of rate. Should you go with a fixed fee or a variable fee? There is no right or wrong answer. It just depends on your situation and your tolerance for risk.

According to CanadianMortgageTrends.com, when looking at which types of mortgages that Canadians are choosing, 74% of households buy their homes with a fixed fee mortgage and 21% with a variable fee. The remaining 5% are hybrid mortgages.

What is a hybrid fee mortgage?

Fixed and variable fees aren’t the only options available. A hybrid interest rate mortgage is a combination of both types of interest rates. A hybrid combines a variable rate and a fixed fee into one mortgage product for homeowners who want the best of both worlds. It can also help hedge their bets a little bit more than going all-in with one style.

Fixed fees have their benefits, but what if a homeowner wants to also take advantage of a variable rate? That’s when they would choose the hybrid option to have both types of mortgage rates at once as opposed to putting all of their eggs into one basket.

With a hybrid mortgage, part of the total value of the mortgage is locked in with a fixed fee. The remaining amount uses a variable rate. This isn’t a very popular option and isn’t on the radar for most people. There are different ways that people can choose to hedge their bets when it comes to interest rates.

What are the benefits of a fixed fee interest rate mortgage?

There are a handful of benefits of a variable fee, but just one main benefit of a fixed fee. A fixed fee will stay the same. It’s predictable, it’s safe, and it’s not flashy. It may end up costing more in the long run, but Canadians are generally okay with paying a small premium for the sake of stability and predictability.

Additionally, many homeowners are on a fixed budget —to a point where they are concerned that they cannot afford a potential increase in their mortgage without having to make other sacrifices in their spending. Therefore, keeping their monthly fee locked in with a fixed fee allows them to budget more accurately and avoid any surprises that could leave them unable to meet their mortgage payments.

When push comes to shove, many households are willing to spend a little bit more in order to avoid having to worry about the ebbs and flows of the interest rate market. A fixed mortgage offers this stability, so that’s why many homeowners have chosen a fixed mortgage.

What are the benefits of a variable fee interest rate mortgage?

Variable rates are usually lower than the fixed fee. This is why you will generally save money by going with a variable rate compared to a fixed fee.

Nonetheless, there are situations where interest rates rise. It’s possible that a variable mortgage will end up costing you more in the long-term when compared to fixed mortgage rates.

Even a difference of 0.3% or 0.6% can add up to a lot of money throughout the course of a mortgage. When people are choosing between rates, there can be a lack of awareness about how much money that small difference in percentage actually adds up to throughout the mortgage term.

One of the more interesting aspects of a variable fee is that if you pay attention to the Bank of Canada’s prime rate and you notice that it starts to rise and you’re concerned about the trend, then you can switch from a variable fee to a fixed fee. The plus side is that, to some degree, you’re getting to have your cake and eat it, too. However, it’s always possible that you might end up locking in your rate and then the Bank of Canada prime rate starts to drop. This means you’ve locked yourself in at a higher rate.

Also, if you have a mortgage term of five years, then you can also reconsider between fixed and variable rates after five years have passed. It could be that fixed fees make more sense five years from now. Or, if your priorities have shifted, then pay a bit of attention to the prime rate and factor this into your decision. There’s no way to know for sure how the Bank of Canada interest rate will change, but you can pay attention to the rates, how they’re moving, and how that may impact your payments.

What happens when variable rates go up?

When a variable mortgage rate increases, you may end up having to pay a little bit more each month. However, that’s not always the case—at least not in a way that will make a huge difference in your day-to-day life. If there is an increase, then it will likely be very small. A lot of that change will simply translate into having to pay off your mortgage a little bit longer because more of your monthly payment will be going towards the interest as opposed to than paying down the principle. When rates rise, it can still make a dent in your monthly payments and budget, but it’s unlikely that it will be catastrophic.

What are some things to consider when choosing an interest rate?

If you take a look at the past, homeowners who have opted for a variable fee have saved money in the long run. There have been studies that have compared, historically, different types of mortgages. Variable rate mortgages have been more likely to save money for homeowners. This past performance doesn’t guarantee that variable fees will always be the best option in the future, but it gives you a starting point to consider.

Despite the better historical performance of variable rates, the fixed option is still the much more popular one. Why is this? It tends to be that homeowners are more aware of risk and avoiding it. They would rather pay a little more in order to have less potential downside.

Some additional things to consider when looking at the different styles of mortgage rates are:

  • How much you can afford to pay towards your mortgage each month.
  • If your budget has enough breathing room that you’ll still be able to keep meeting your monthly obligations even if rates fluctuate.
  • How long you’re planning on living in your new home .

You can also take a look at recent trends in interest rates, but just looking at the charts without having all of the context of what has impacted the rates over the years can lead you to making some false conclusions. Even economists don’t always come to an agreement on where the interest rates are heading, so trying to do that as a layman is probably an exercise in futility.

How should I make my decision?

Knowing that a variable rate mortgage is more likely to save you money in the long run isn’t a convincing enough argument for many Canadians. Being locked into a rate that’s based on the prime rate is more appealing for many households—even if it means spending more money by having higher interest rates throughout the life of the mortgage. The main benefit of a fixed fee is the stability that comes from an interest rate.

If you’re in the market for a mortgage, then don’t hesitate to consult with a professional mortgage broker. They can run the numbers and compare fixed fees with variable fees.