What is the difference between a fixed and variable interest rate?
A fixed rate is an interest amount that a borrower and a lender have agreed to during a term of the mortgage, typically 5 years. The borrower is guaranteed this rate for the term of the mortgage. The mortgage payments are also fixed unless a borrower takes advantage of their prepayment privileges.
A $200,000.00 mortgage amount for an interest of 3% for 5 years will have a fixed monthly payment of $948.42 every single month for 5 years.
Individuals who prefer predictability will typically select a fixed interest rate option.
A variable interest rate mortgage will have an interest rate that changes, or varies, during the term. A lender will peg their rate to the Bank of Canada’s interest rate. For instance, a borrower may have a variable interest rate of prime rate MINUS .45%. Presently, Bank of Canada’s prime rate is 2.45%. Let us assume that the lender’s prime rate is the same as Bank of Canada’s interest rate. This will mean that the interest rate will effectively be 2%.
The mortgage payments may or may not change during the term, depending on the mortgage terms. Regardless, if the prime rate changes, this will mean your effective rate changes, which will impact the amount of your mortgage payments applied to your interest, rather than your principle.