Fixed vs Variable Rate Mortgage

How Fixed Rate Mortgages Work

A fixed rate mortgage locks your interest rate for the entire term, typically one to five years in Canada. Your payment amount stays the same every month regardless of what happens in the broader economy. The rate is set at signing and does not change until the term ends and you renew.

Fixed rates are usually higher than variable rates at the time of signing. That premium is the cost of certainty. You are paying for the guarantee that your rate will not increase, even if the Bank of Canada raises its policy rate multiple times during your term.

How Variable Rate Mortgages Work

A variable rate mortgage is tied to your lender's prime rate, which moves in step with the Bank of Canada's overnight policy rate. When the Bank of Canada raises or lowers its rate, your lender's prime rate adjusts accordingly, and so does the interest portion of your mortgage payment.

There are two types of variable rate mortgages in Canada. An adjustable rate mortgage changes your actual payment amount when rates move. A variable rate mortgage with fixed payments keeps your payment the same but adjusts how much goes toward principal versus interest. With fixed payments, a rate increase means more of your payment goes to interest and less to paying down the balance.

Payment Scenarios: What Happens When Rates Move

To illustrate the real impact, consider a $600,000 mortgage amortized over 25 years on a five-year term.

Starting scenario: Fixed rate at 4.99 percent, variable rate at 4.50 percent (prime minus 1.20). Monthly payment on the fixed mortgage is approximately $3,487. Monthly payment on the variable mortgage is approximately $3,317 -- a savings of $170 per month.

If rates rise 1 percent: The fixed payment stays at $3,487. The variable payment increases to approximately $3,634, now costing $147 more per month than the fixed option. Over a full year that shift adds up to roughly $1,764 in additional cost.

If rates drop 1 percent: The fixed payment stays at $3,487. The variable payment drops to approximately $3,006, saving you $481 per month compared to fixed. Over a full year that is roughly $5,772 in savings.

The asymmetry matters. Variable rates reward you more when rates drop than they cost you when rates rise by the same amount, because lower rates mean more of your payment goes directly to principal.

Breaking Your Mortgage: Penalty Differences

This is where the two options diverge significantly. Life circumstances change. You may need to sell your home, refinance, or switch lenders before your term is up. The penalty for breaking your mortgage depends entirely on your rate type.

Variable rate penalty: Three months of interest. On a $500,000 balance at 4.50 percent, this works out to approximately $5,625. The calculation is straightforward and predictable.

Fixed rate penalty: The greater of three months of interest or the Interest Rate Differential (IRD). The IRD compares your contracted rate to the lender's current rate for the remaining term, and the result can be dramatically higher. On the same $500,000 balance, a fixed rate penalty can range from $8,000 to over $20,000 depending on how far rates have dropped since you signed.

If there is any chance you will need to break your mortgage early, the variable rate penalty is substantially lower and more predictable. This is one of the most overlooked advantages of a variable rate.

Historical Performance

Research from the Bank of Canada and independent studies has consistently shown that variable rate borrowers have paid less interest than fixed rate borrowers approximately 80 to 90 percent of the time over the past several decades. The savings come from the fact that variable rates start lower and do not always rise enough during a term to offset that initial advantage.

That said, the period from 2022 to 2023 was a stark reminder that variable rates carry real risk. The Bank of Canada raised its policy rate from 0.25 percent to 5.00 percent in under two years, catching many variable rate holders off guard with significantly higher payments or trigger rate events where payments no longer covered the interest owing.

Historical averages do not guarantee future outcomes. The question is not which option is objectively better but which one aligns with your financial situation and risk tolerance during your specific term.

The Stress Test and Rate Type

All federally regulated lenders must apply the mortgage stress test. You qualify at the higher of 5.25 percent or your contracted rate plus 2 percent. This applies to both fixed and variable rate mortgages.

In practice, the stress test means that choosing a variable rate does not let you borrow more money. Even though your actual payments may be lower with a variable rate, you must prove you can afford payments at the stress test rate. Both options result in the same maximum borrowing amount.

The stress test does, however, provide a built-in buffer. If you qualify at 5.25 percent and your variable rate is 4.50 percent, you have demonstrated that you can handle a rate increase of at least 0.75 percent before reaching your qualification limit.

Choosing the Right Option

There is no universally correct answer. The right choice depends on your personal financial situation, your tolerance for uncertainty, and your plans for the property. Consider these factors:

• Your financial cushion. If your budget is tight and a $300 monthly payment increase would create stress, fixed gives you certainty. If you have room in your budget to absorb fluctuations, variable may save you money over time.
• Your time horizon. Planning to stay in the home for the full five-year term? Fixed removes all rate risk for that period. Might you sell or refinance in two to three years? Variable offers a much lower penalty if you break the mortgage early.
• The current rate environment. When variable and fixed rates are close together (within 0.25 to 0.50 percent), the savings on variable may not justify the uncertainty. When the gap is larger (0.75 percent or more), the initial savings on variable provide a meaningful head start.
• Your personal comfort. If Bank of Canada rate announcements make you anxious, the peace of mind from a fixed rate has real value. Financial stress affects decision-making in all areas of life.

Frequently Asked Questions

Can I switch from variable to fixed during my term?

Most lenders allow you to convert from variable to fixed at any point during your term, but you will receive the lender's current posted fixed rate for the remaining term, which is typically higher than the discounted rate you would get by shopping around. Some lenders may charge an administrative fee. Converting from fixed to variable is generally not possible without breaking the mortgage.

What is a trigger rate?

If you have a variable rate mortgage with fixed payments, a trigger rate is the point where your payment no longer covers the interest owing. When this happens, your lender will typically require you to increase your payment or make a lump-sum payment to bring the mortgage back on track. This became a real issue for many Canadians during the 2022 to 2023 rate hike cycle.

Does my choice affect how much I can borrow?

No. The stress test ensures that your maximum borrowing amount is the same regardless of whether you choose fixed or variable. You qualify at the higher of 5.25 percent or your contracted rate plus 2 percent either way.

What about hybrid or split mortgages?

Some lenders offer the option to split your mortgage between fixed and variable portions. For example, you might put 60 percent on a fixed rate and 40 percent on variable. This gives you partial protection against rate increases while still benefiting from some variable rate savings. Not all lenders offer this, and the terms vary, so ask your broker about availability.

Should I use a mortgage broker for this decision?

A mortgage broker can compare rates across multiple lenders and help you evaluate the fixed versus variable decision based on your specific financial profile. Brokers are paid by the lender, not by you, for standard insured or insurable mortgages. Their access to a wider range of products can be particularly useful when the rate environment is uncertain.