What is the difference between a fixed rate mortgage and a variable rate mortgage?
With mortgages you pay a price for certainty. You generally pay more for a fixed rate mortgage because the lender is taking the risk as to what the rates will do by fixing the rate for you. You generally pay less for a variable rate mortgage because it is you that is taking the risk of uncertainty as to how interest rates will move – up or down. When you take out a fixed rate mortgage, your interest rate will never change throughout the term. As a result, you will always know exactly how much your payment will be. With the Variable rate mortgage, your interest rate may vary from month to month. Historically, variable rate mortgages have tended to cost less than the fixed rate mortgage. When rates change, your payment remains the same, but the amount that is applied toward interest and principal will change. If interest rates drop, more of your mortgage payment is applied to the principal balance owing. This can help you pay off your mortgage faster.
In a fixed rate mortgage, the interest rate is pre-determined at the beginning of the loan term, which can range from 6 months to 25 years. The advantage of this type of mortgage is that it offers a security of knowing your monthly payments beforehand and allows you to plan accordingly. In a variable or floating rate mortgage, the payments are fixed for a period of one or two years but the interest rates can fluctuate every month depending on the market conditions. If the interest rates drop, more of the payment goes towards reducing the principal; if the rates go up, a larger portion of the monthly payment goes towards covering the interest. The interest rate is based on a predetermined formula which is in-turn based on the prime-lending rate.
