Going through the mortgage process for your first home in Canada can be a challenge if you don’t know in advance which type of mortgage is right for you. Of course, your broker will advise you on the options which are available. However, it is important you understand the process for selecting the right mortgage for your own individual needs. Your broker will be able to direct you as to which option they feel is the best.
As this is one of the first major decisions you will need to make with regards to your mortgage, we wanted to give you a little bit of extra information on the subject. In this article, we will explore the differences and key benefits of both a variable and a fixed rate mortgage.
Variable or Adjustable-Rate Mortgage
Part of selecting the right mortgage is learning a little about variable rate mortgages. Also known as ARM’s, the adjustable rate mortgage will run from around 3-5 years. Over that period of time, the interest rate that you are charged will fluctuate either up, or down. This means that your monthly payments are variable and are subject to change. This type of mortgage is preferable if you are not planning on staying in the property on a long-term basis. It is also suitable for those who do not mind the payment fluctuations, or whose income may increase in the future.
The market interest rate is known as the prime interest rate. Now, of course, this option does come with a slight risk. If interest rates take a turn for the worse, then you could be faced with an increase in payments for the remainder of the loan period. However, historically, variable rates have been proven over time to not cost as much as what a fixed rate mortgage will.
A variable interest rate might change when there are movement with the prime rate of lending; this is the rate in which lenders will borrow money to their most creditworthy clients. A variable interest rate will often be referred to as prime plus, or minus a specific percentage. A good example of this is referred to below.
Variable Rate = Prime – 1.2%. If the prime rate is 7%, then you will pay 5.8%.
Fixed Rate Mortgage
Selecting the right mortgage may include a fixed rate mortgage. The term of a fixed rate mortgage can be anything between 1-10 years. As the name suggests, the interest rates of fixed and the payments will not fluctuate at all for the duration. If you plan to live in your house for 5 years or more, this could be the ideal option for you. It also means that you know precisely what you will be paying each month and can plan your finances accordingly. If you believe that your income will stay the same for the foreseeable future, then this could be a great choice of mortgage option to take.
You will often see that a fixed mortgage rate is somewhat higher than a variable interest rate. With a fixed rate mortgage, you can always know what your payments are going to be, which can be a much easier and stress-free option to choose. If, however, there is a big difference between the fixed and variable rates, it might not be worthwhile paying out a significant amount of money just for this added security.
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Making The Best Decision
Selecting the right mortgage for you means making the best decision. If the current interest rate is considered to be low, it might be a better option to lock yourself into a fixed rate, preserving the low rate for the duration of your loan. If, however, they are high, or expected to fall, then a variable rate would be a better option to take.
With a fixed mortgage the penalties do apply if your sell or break the mortgage before the end of the fixed term. If you may break your term early a Variable Mortgage is a better option.
Although the majority of the fixed term loans might seem the same, there are some intricate options such as prepayment or portability features that can be quite useful further down the line.
It all depends on the state of the market at the time you apply, and also, of course, the interest rates that are available to you. Your mortgage broker will be best placed to be able to help you choose with choices, or mortgage terms will be ideally suited to your own situation. A good broker will offer you several options to choose from and should go into some detail about each borrower and the product they are offering to you.