The variable vs fixed mortgage rate decision is one of the biggest a borrower will make when selecting their mortgage. 

It’s a decision that will affect a homeowner for years to come and could be the difference in literally thousands of dollars of the interest cost. 

In 2022 as the effects of Omicron coronavirus continue to sweep through Canada and our economy, we will see that, even though fixed rates are still very low, and are a fantastic solution for many, the answer for most people, is still variable.

If this is all you need to make a quick and decisive decision, then great. You should do well with this advice. However for those who would like to see the compelling reasons why, at this specific point in history, the variable rate makes more sense than fixed for most people, then I invite you to read on.

variable vs fixed mortgage

 Variable or fixed mortgage in 2022? Which is right for you?

To help determine this, we will look at:

  • The difference between variable vs fixed mortgage rates.
  • 6 Reasons why a variable rate should lead to more savings now, and for years to come, including:
    • Historical, long term evidence of variable rate cost savings. 
    • Effects of COVID and Why the variable rate should not increase by as much as some expect, or as fast (special 2022 update)
    • A note on current high inflation, and historical perspective on rate movements (special 2022 update)
    • How to minimize the risk associated with a variable rate mortgage.
    • How variable rates offer more flexibility and lower penalties than fixed rates. 
    • How to time a fixed rate lock in (special 2022 update)
  • Why a fixed rate mortgage will still be the best path for many.

Variable vs Fixed Mortgage Rates: Features Compared

The short video just below will simplify the variable vs fixed mortgage rate differences and provide a good basis for our discussion.

To summarize:

Fixed Rate:

  • Locks your rate into place for a period of time called the term (usually 5 years).
  • Rate is typically a bit higher, but provides for a stable, consistent mortgage payment for years to come.
  • If you break the mortgage, there is often a bigger penalty called an Interest Rate Differential Penalty.
  • It is not possible to switch a fixed rate into a variable rate without breaking the mortgage.

Variable Rate:

  • The rate floats or changes over time, with decisions from the Bank of Canada.
  • The rate is determined using a discount off of the Prime Rate (ex. Prime minus .50%).
  • Typically, the variable rate is lower than fixed, but can also float higher for periods. 
  • If you break the mortgage, the penalty is typically far lower.
  • You can lock the variable rate into a fixed rate at any time, without breaking the mortgage.

Variable Mortgage vs Fixed: 6 Reasons Why Variable is Better in 2022

Variable is Historically and Statistically Shown to Cost Less than Fixed

According to a 2001 report completed by Moshe Milevsky, Professor of Finance at York University Schulich School of Business, variable mortgage rates beat 5 year fixed rates 70% – 90% of the time. 

Using data from 1950 – 2000 the study includes a period of high market volatility in the 1980s and 1990s where mortgage rates were much higher than they are at present. This means that the data used in this study is not selected during a period that would manipulate the results to favour a variable rate over a fixed rate. 

In fact, I believe it’s quite the opposite. I believe that the rate volatility in the 1980s and 1990s skews the argument more towards fixed rate and that it is more likely for rates to remain far lower for at least the next decade. 

With this said, in the author’s words “When interest rates are at low levels, one is better off locking in at long term rates”.

In other words, the author of the study suggests that variable rates are the better choice, but locking into a fixed-rate mortgage at the right time is ultimately the goal. We will address the variable rate lock in feature, later in this article. 

On a side note, some will point to the period of higher interest rates during the 1980s and 1990s as a reason to avoid a fixed rate. However, as we will review below, we live in a very different, debt-laden economy now whereby the effects of a 1%  higher Central Bank rate can have 5 – 10 times the economic impact as a 1% higher rate did in the 1980s. 

Therefore, I contend that unless we see substantial economic GDP growth and faster inflation increase, we are not likely to see the kind of high rates that were seen in the 1980s and 1990s.

Variable Mortgage Rates Canada Prediction: Effects of COVID (and Why the variable rate is not likely to increase too much, too quickly).

As the effects of COVID, unfortunately, continue to take their toll on the broader Canadian and global economy, it is likely that, as of 2022, it will take several years for the economy to more formally stabilize and grow. 

The economy indeed can be thought of like a giant ship that can take a while to turn around.

One of the biggest mechanisms that the government has to stimulate an economy is its control over interest rates through the Central Bank of Canada. 

If interest rates are kept low – this lowers costs of borrowing which does two main things:

  • It reduces what borrowers need to spend on interest, so borrowers have more money to spend on other things in the economy.
  • It makes borrowing more attractive, so people borrow more, and spend more with this borrowed money – and this boosts the economy.

So my main variable mortgage rate prediction here is that the Government of Canada will want to keep interest rates relatively low for a long period of time because the economy needs continued stimulation, given the effects of coronavirus. The Central Bank of Canada will not likely increase rates too much, or too quickly until they are more certain that the economy is on track for sustainable long term growth, post covid. 

Inflationary effects on mortgage rates

Most are aware that inflation has gripped the world and Canada more specifically, in large part by crippling supply chains and limiting products available to customers. Naturally, a limited supply and excess demand will lead to higher prices – or inflationary pricing.

Again, the main tool the central banks have to combat inflation is their ‘central bank rate’.  As noted above, by increasing this rate, consumers can not afford to borrow and purchase as much (or are at least dis-incentivized to borrow/purchase), and business do not borrow as much to purchase with either. This has the effect of reducing demand, slowing the economy, and in turn, reducing inflation.

It is argued here that:

(1) The economy is still too fragile, in the midst of the pandemic to substantially increase rates. In addition, there will be lingering economic after effects of covid-19 and increased debt loads, without as much government cash stimulus in the picture. Yes, a 0.75% or even 1.00% rate increase in 2022 is possible, but it takes almost a full year to ‘bake in’ the higher rates, into the economy so the Central Bank will be very careful about how much, and how quickly they increase rates, in 2022.

(2) The cause of high inflation – crippled supply chains – will be remedied in 2022, and likely sooner than consensus economists project. As of January 2022 there is already some indication that inflation may start to fall (‘Prices Paid Trend indicator’ that leads Consumer Price Index by 2-3 months is sharply lower, generally lower gas/ energy prices, commodity prices such as lumber well off their highs, improving inventories/ supply in some hard hit areas of the economy…). This will mean government has less inflation to ‘battle’ and less motivation to increase rate in 2022.

Indeed, in December 2021 the Central Bank of Canada reiterated its belief that inflation will decrease and “ease back towards 2 percent in the second half” of 2022.

When the economy GDP does eventually start growing at a strong, natural pace – not a cash stimulus and inflationary based price growth, but real growth – the Central Bank of Canada will need to be careful how quickly they increase rates, and by how much – because our economy simply can’t handle too much rate increase too soon. It simply isn’t ready.

A historical note, providing future context…

Looking back to the great recession in 2008-2009 brought on by the housing market crisis in the US, and given the economic stimulus required to bail out the economy at that time,  it led to almost 10 years of low low interest rates and mortgage rates. Now, in covid times, we see a similar kind of massive stimulus that was required to save the economy. As a result, more than likely we are now in a new era of relatively low rates given the amount of new debt, stacked on already massive government and private debt. Accordingly, near-medium term economic growth may very well be more debt dependent, and stagnant.

Variable-rate mortgage holders stand to benefit most from this low rate interest environment over the next 1-2 years.

Fixed or Variable Mortgage: How to Minimize the Risk Associated with a Variable Mortgage

Here we revisit the fundamental question of why we are even taking the time to discuss a fixed or variable mortgage. The answer for most is to save more money on their mortgage, in one way or another. 

The strategy here will show you how to lower your risk on a variable mortgage while also setting you up to save substantially on interest over time.

I call this more specifically, ‘variable rate risk mitigation’ and it involves using the extra payment/ prepayment privileges found in the mortgage fine print terms to increase your variable mortgage payment to the same payment that you would be making at a higher rate 5 year fixed rate mortgage.

For example:

5 Year Rate 2.49%

$300,000 mortgage

25 YR Amortization

Payment: $1,342

Variable Rate 2.00%

$300,000 mortgage

25 YR Amortization

Payment: $1,270

Then using prepayments, boost the variable payment  by $72 per month to $1,342 – the same payment as you would have been making on the fixed rate.

Variable vs fixed rate mortgage: Pre Payment Result

By increasing the payment on the variable rate to be on par with the fixed rate, we are taking advantage of the variable vs fixed rate mortgage to pay down the mortgage faster. 

This helps to reduce risk because as we spend time getting ahead on payments near the beginning of the mortgage, it buys us time later on in the term when rates are more likely to increase. 

Even if variable rates surpass, or go higher than the fixed rate comparison, it would still take some time – perhaps years – for you, the borrower, to actually end up paying more for the variable rate mortgage vs fixed rate mortgage option.

This concept will be expanded on below, with more specific reference to timing.

Variable rate mortgage vs fixed rate mortgage: Not if but when rates increase

When variable rates eventually start increasing again, and your payment increases as a result of the variable rate increase, you could simply remove the additional pre payment that you were making at the beginning of your mortgage to help keep your payment more consistent over time. 

So even though you would not be hammering away and getting ahead as quickly as you were, you would have already made substantial progress on your mortgage, and you could have the peace of mind of a built-in mechanism to keep your mortgage payment more consistent.

We will take a more in depth look just below, on how this might look over the next 5 years.

Altrua Financial can work with you to easily implement this kind of risk mitigation strategy with the lowest rate variable mortgage.

Variable mortgage vs fixed: How variable offers more flexibility and lower penalties than fixed 

Closely related to lowering risk as seen in the last point, the lower penalties and increased flexibility built into a variable rate mortgage are a cornerstone of a variable rate.

When looking at a variable vs fixed mortgage, it should be taken into account that, especially during the first 3 years of a fixed rate mortgage, the penalty to break the mortgage can be extremely high.

As a mortgage broker for over 15 years, I have seen many individuals faced with massive ‘interest rate differential penalties’, when breaking their mortgage for any number of reasons:

  • Moving
  • Refinancing to pull out equity
  • Switching into a lower rate
  • Family changes
  • Many more…

This trend was especially the case in 2021 as many who are in a fixed-rate mortgage in the mid to high 2% range were faced with cost-prohibitive penalties in the $10,000’s to break their higher-rate mortgage. This was not the case for those in a variable rate mortgage, and this kind of flexibility could certainly come into play in 2022-2023 as rates may threaten to increase.

While a detailed discussion of penalty details is beyond the scope of this article, the point is that most variable rate mortgages (the ones without terrible fine print) will only ever charge 3 months interest penalty if you end up breaking the mortgage. The 3 month interest penalty is far lower – often to the tune of thousands of dollars lower than comparable fixed rate mortgage penalties.

Five years, the typical mortgage term, is a long time, and it can be difficult to tell exactly the way things will play out further down the road. So an important financial planning strategy is to remain flexible and agile to help accommodate changes. 

The variable rate mortgage is, in many cases, the right financial tool to help accommodate these changes.

I also contend that the lower penalty of a variable rate, offsets much of the risk associated with a fixed vs variable mortgage.

Timing a Fixed Rate Lock-In?

The points mentioned so far mainly apply to the period where you are in a variable rate. 

 One of the fundamental benefits of a variable rate is the ability to lock into a fixed rate.

First, it is helpful to understand the difference between fixed and variable rate pricing. The key to understanding  fixed rates, is that they are bond market driven (bonds being Canadian national debt, in the form of a tradable debt instrument, and traded on international markets). In other words, the central bank does not increase or decrease fixed rates, the bond traders, and their perception of where central bank/variable rates will end up in 6 months – 1 year down the road, will in a highly correlated way, price the fixed rate sooner than later. In other words, the pricing of the fixed rate is an anticipation of where the variable rate will go in the short – medium term.

There may be some volatility in fixed rates, in early 2022 – leading towards a fixed rate decrease in 2022 (because of Omicron variant, supply chain recovery, reduction of inflationary forecast, and fundamental economic woes).

So timing the lock in to a fixed may be more difficult to anticipate in 2022, and the main advice currently, if you decide on a variable rate is to plan on holing the rate even as variable rates increase throughout 2022 and 2023, and NOT locking into a fixed any time soon. With such significant discounts in variable rates currently, as of January 2022, there is a lot of runway for variable to catch up to fixed.

Accordingly, there is substantial savings and ‘risk mitigation’ (as discussed above) that may be had until the point where your variable rate, catches up to the fixed rate, and even then – you have not yet lost. Indeed, if you save with your variable rate for the first half of your term, then rates will need to go up enough in the second half of the term, to ‘pay back’ those savings to truly break even. This would require perhaps a 2.5% – 3% increase in the variable rate in the next 5 years (with the higher rates weighted towrds the second half of a 5 year term), which, for the reasons discussed previously, is not likely.

Variable Vs Fixed Savings: A realistic example/ scenario

If you start of with a 1.25% variable rate today. You could have been approved for a 2.54% 5 year fixed rate.

In 2022, the variable rate increases by 0.75%. So you are now at 2%. The government/ central bank decides to wait 6 months to see what the after effects are, of the rate increase.

Nothing too bad surfaces economically in 2022, so in early 2023 the rate is increased another 0.25% and then in mid 2023 the rate increases by another 0.25% for a total 0.50% in 2023, bringing your variable rate in early 2024 to 2.50% or right about what you would have paid for a fixed rate. Hypothetically, the government leaves rates for another 6 months without increase, to see the effects of the increase, brining you to 2.5 years into a 5 year term, or half way through the term.

Now the question is – how much have you saved for that first half of the term? You will likely be thousands of dollars ahead, in interest savings.

Now rates have to continue increasing, another 1% – 2% in the second half of the term, for you to ‘pay back’, or break even with a fixed rate borrowing cost, let alone lose versus a fixed rate.

Given an example scenario, such as described above, rates would have to increase very significantly and very quickly, for you to lose versus a fixed rate.

At Altrua Financial, mortgage brokers, we routinely conduct specific cost benefit analysis for clients to help ensure their best rate decision, savings and peace of mind for their mortgage term.

The conclusion here, is NOT to lock in a fixed fate during the term, and instead to ride out the rate increases, as more than likely the increases will not be too much, too soon.

Variable- Fixed Rate Lock in exceptions 

The information in this article is an opinion, based on in depth research and significant experience. However if inflation or some other economic anomaly becomes out of control, it could absolutely make sense to flick the safety switch, pull the parachute, and lock in to a fixed rate.

OR if there is another recession within 5 years, and central bank rates are lowered, there could be an opportunity to lock in to a fixed rate, in the low- high 1% range. From this perspective, a variable rate can indeed be see like an insurance policy against a recession during the term.

Why a fixed rate mortgage will still be the best path for many.

There’s nothing that will ruin one’s credibility like being 100% one sided for one idea or another, and this can’t be more true when looking at the variable vs fixed mortgage discussion.

I believe that the variable strategy described above is best for many, but not all mortgage holders.

There is one golden aspect of a fixed mortgage rate that is hard to put a price on: peace of mind.

How does one measure peace of mind? It’s nearly impossible to measure and the value of it can be near infinite. 

Fixed rate mortgages are designed to provide peace of mind, and with rates at such low levels as they are at in 2021, how could you really go wrong by keeping things simple.

‘Set it and Forget it’

I have attempted to show why and how a borrower is likely to save money with a variable rate-fixed rate timed strategy, however what’s the point in saving money if you’re constantly stressed out about it.

There are no guarantees out there, only past experience and likelihoods.

So, for those of you that have made it here to the end, perhaps the real conclusion of the fixed or variable mortgage conversation should instead be: Fixed and variable are both the best decision – depending on who you are. 

For current information on what kind of mortgage term may save you the most money, view our article here.

For the best mortgage rates, check out our rates here.