What you never knew about the benefits of a variable rate mortgage

In a fixed-rate mortgage, the interest rate never changes. As the name suggests, with a variable-rate mortgage, the interest rate varies throughout the life of the loan. This happens when the Bank of Canada decides to change the cost of borrowing as the economy heats up or cools down. These types of loans also include "adjustable rate" mortgages (ARMs). ARMs often offer a fixed interest rate for a set number of years, and then switch to a variable rate for the rest of the loan's lifespan.

On the face of it, a fixed-rate mortgage gives borrowers peace of mind. Homeowners have a predictable housing payment for a set period of time. A 5-year fixed-rate loan, for example, means the borrower pays the same amount each month for the agreement period — in this example, 5 years.

Knowing that you have a guaranteed monthly payment that won't change can lower stress over money matters. For this reason, fixed-rate loans are attractive to some people. But they can come at a price — we'll get into that in a moment.

Borrowers who can live with a modest amount of uncertainty about their housing payment may find themselves better off with a variable-rate loan.

"Variable mortgage rates have proven to be less expensive compared to fixed rates when examined historically," states financial information website RateHub.ca Opens in a new window.. If you can deal with your monthly housing cost moving up and down a little, you may save money at the end of the day.

Let's look at an example: Simplii recently offered adjustable-rate home loans at an annualized rate of 1.34%. That compares to an average rate of 2.74% for a loan with a 10-year fixed-rate period, according to August 2021 data from RateHub.ca Opens in a new window.. While the difference between those 2 borrowing costs may seem small, just 1.4 percentage points, the dollars and cents add up.

Using these example rates for a $400,000 loan, the variable-rate mortgage will cost $273.35 a month less than the fixed-rate loan, according to my analysis. That's equal to around $3,280 a year, or more than 2 entire monthly payments for the adjustable-rate loan. Over 5 years, the total would amount to $16,400. All calculations assume a 25-year amortization, or the length of time it takes to pay off a mortgage in full.

That's a lot of money that could potentially be socked away in a high-interest savings account, assuming that the monthly adjustable-rate mortgage payment doesn't increase.

If the borrowing costs do jump, there's no reason to panic. Your increased cash in the bank could cover any shortfall. In other words, the lower monthly housing cost lets you build a nest egg faster, which helps reduce financial anxiety.

There's another reason to consider an adjustable-rate mortgage over a fixed-rate one. It comes down to something simple: most people don't want to spend money when it isn't necessary. You wouldn't buy a lawnmower if you had no grass to cut.

The same logic applies for taking out home loans with a fixed interest rate. Typically, the cost of borrowing is more expensive the longer the interest rate is guaranteed to be stable. That's why a 10-year fixed-rate mortgage generally has a higher interest rate than a 5-year fixed-rate mortgage Opens in a new window.. The borrower using a 10-year fixed-rate loan is paying extra for the stability over a longer period of time.

Approximately 620,000 Canadians move house each year. That results in them owning around 5 properties in their lifetime, according to the Canadian Association of Accredited Mortgage Professionals Opens in a new window.. Real estate website Zolo calculates that the average person moves every 7 years over a working career. If you expect to move around a lot, as many people do, then you won't benefit as much from the certainty of a fixed-rate mortgage.

Variable-rate mortgages do have their downsides: the prospect of significant changes in the cost of borrowing can be concerning. The good news is that there are ways to mitigate those worries. For instance, you can request your lender set an interest rate cap. This way, you never have to pay more interest than the maximum cap, even if rates go up. Or you could see if the mortgage is convertible like Simplii's. This allows you to switch your mortgage from one that has variable rates to one with a fixed rate.

Whether a variable- or fixed-rate loan makes sense will depend on your situation and lifestyle, but it's worth investigating all your options when making this big and exciting financial decision.