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A personal finance expert explains the basic differences between variable and fixed mortgages, and closed and open mortgages when buying a house.

Buying a house and getting a mortgage can be a stressful experience, especially if you’re going through it for the first time. Whether you opt for a traditional bank or a mortgage broker, trying to decipher terminology like “amortization,” “open vs closed mortgage,” or “prime interest rate” can make it feel even more overwhelming. With all the jargon being thrown around, it’s easy to get confused and misunderstand important details about what’s likely the biggest purchase of your life.

Having bought three properties in ten years, I’m here to give a crash course on open vs. closed mortgages and fixed vs. variable rates. These are two important concepts to understand before signing on the dotted line of your mortgage agreement, as whatever you choose has a big impact on what you’ll pay over the long-term.

One of the most important things you’ll have to decide is whether to go with a fixed vs. variable rate mortgage.

Let’s look at the differences. Then, come back to this table and see which is best for you.

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What is a Fixed Rate Mortgage?

A fixed rate mortgage is pretty straightforward. Here’s how it works: your lender offers an annual percentage rate and term, such as 2.80% for five years on a $500,000 loan, which will be paid back over 25 years. Since it’s a fixed rate mortgage, the interest rate will stay at 2.80% for the full five-years, even if the prime rate fluctuates during that time period (more on that later). With a fixed rate, you make the same monthly, bi-weekly, or weekly installments, which goes towards paying down both the interest and the principal (the amount you borrowed).

A fixed rate mortgage tends to be a favourite among Canadians because it offers peace of mind. According to the Mortgage Professionals Canada (MPC), 68% of borrowers who purchased a home in 2018 chose a fixed rate mortgage. It’s easy to see why: you know exactly what your mortgage payment will be every month and it never changes (at least, until the term is up). That way, you can make a budget that will help you live within your means.

The cons are that this security blanket comes at a cost. Fixed rate mortgages are usually higher than variable rate mortgages. Also, if variable interest rates plummet, you’ll be stuck paying a higher interest rate.

What is a Variable Rate Mortgage?

Like fixed rate mortgages, variable rate mortgages (VRMs) also have a set term (e.g. 5 years), but they have one big difference: the interest rate can go up and down during your mortgage term. This can happen as often as every month, as it’s tied to whatever is happening with the rate set by the Bank of Canada.

How does it work? The variable rate is related to the prime interest rate, which refers to the interest rate that a bank offers to their most trusted customers. This preferential rate is based on the Bank of Canada’s overnight rate or key interest rate – which is the interest rate at which banks get money from the Bank of Canada.

The bottom line: if you choose a VRM, your payment will go up or down depending on what the Bank of Canada does and how your lender reacts with their prime interest rate.  While some people think can predict what the Bank of Canada is going to do, the truth is that no one has a crystal ball and can see what interest rates will do over the long term.

You may see banks advertise their variable interest rates as “prime minus 0.2%” or something similar. This means that you will get 0.2% off of the floating prime interest rate – which could go up or down (or stay the same) throughout your mortgage term.

Another consideration for VRMs: set vs. fluctuating payments. You have a choice with VRMs: make set payments (the same amount for every payment) or payments that fluctuate. If you choose a VRM with a fluctuating payment, your mortgage payment can change at any given time. In contrast, for VRMs with set payments, you’ll pay the same amount every time. For instance, if you’ve agreed to pay $1000 bi-weekly, it will stay $1000 – no matter what happens. But if the rate drops, more of that $1000 will go towards paying down the principal balance. If the prime interest rate increases, more of the payment will go towards paying off interest. Ultimately, this impacts your amortization schedule – meaning the time it will take to repay your mortgage in full.

A big pro is that VRMs tend to be a lower interest rate than a fixed rate mortgage. According to the Mortgage Professionals Canada (MPC), the average difference between a fixed and variable mortgage rate in 2018 was 0.55%, which works out to about $85 per month difference in payments. Historically, VRMs cost less in interest over the mortgage amortization, and you can save a bundle if you go with a VRM.

The cons? Your interest rate could go up suddenly, so make sure you can afford your property if this happens. For instance, if you buy a property at the very top of your budget, a hike in the interest rates could jeopardize your ability to make payments on your home. Just do the math before committing to a VRM.

Variable vs. Fixed Rate Mortgage: How to Choose

Choosing between a variable vs. fixed mortgage really comes down to your financial circumstances. Are you comfortable with fluctuation payments? Do you have debts or big-ticket expenses to tackle in the near future? Is your employment precarious or do you have a steady paycheque coming in every month? Is your priority to pay off your mortgage early or invest the extra cash? It’s really a personal choice and you’ll need to crunch the numbers to figure out which one is right for you.

There is a third option when it comes to mortgage interest rates called a hybrid mortgage.  This is essentially when a mortgage agreement has a certain portion of the amount borrowed as a fixed rate, and the rest as a variable rate.  This option is rarely chosen by Canadians but can offer an interesting middle-ground when it comes to risk and reward.

Start by shopping around for the lowest interest rate on the market. A good place to start is one of the best online banks, as their rates are often rock bottom.

Another great option is to use an online mortgage broker, like Breezeful. Search more than 30 banks to get the most competitive rates in just minutes – far faster than approaching banks directly – through its online platform. You’ll have a mortgage expert available to walk you through the process step-by-step and close the best deal on your behalf. Any time you have questions about your mortgage just text them to an advisor through a dedicated text line.

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If you’re stressed about the mortgage stress test, consider a credit union like Meridian. As a provincially regulated financial institution, Meridian has more flexibility than traditional banks when it comes to the mortgages they offer and approve. The stress test can help evaluate whether a mortgage is a good fit for a borrower,  but at Meridian, you’re not automatically disqualified if you don’t pass it. This is because they consider other factors, like income appreciation, accelerated payment options, and overall principal reduction. The bottom line: if you don’t pass the stress test, a credit union like Meridian will work with you to find flexible solutions — making it easier to afford your dream home. Plus, Meridian has some fantastic fixed and variable rate mortgages (some of which are even lower than the big banks!), as well as plenty of mortgage options to suit your circumstances.

What is an Open Mortgage?

With an open mortgage, you can pay off your mortgage at any time without a penalty. However, the interest rates for an open mortgage tend to be variable and much higher.

What is a Closed Mortgage?

In contrast, a closed mortgage has rules about how much you can pay down on your mortgage. If you pay down your mortgage before the term ends, your lender will charge you a hefty penalty.

It may feel like you’re locked in with a closed mortgage but remember that most lenders allow you to make “pre-payments” (extra payments over and above your normal mortgage payment) up to a certain amount annually. This allows you to pay a certain percentage of the original mortgage amount without penalty. Meanwhile, full payoff requires that you pay a penalty – unless you wait for your maturity date. So, if you suddenly find yourself swimming in cash, a pre-payment on a closed mortgage can still be a good option.

Open vs. Closed Mortgage: How to Choose

Again, there’s no “right” choice here: it really depends on your financial situation and personal preferences. Generally, most Canadians prefer the simplicity of a basic closed mortgage with fixed interest payments. It’s easy to understand and there are no surprises. But if there’s a chance that you may inherit a wack of cash in the near future, you may want to opt for an open mortgage so you pay it off faster and incur less interest.  It’s totally up to you.

Last Word: How to Find the Best Mortgage?

The most important take away is that you really need to do your research to find the best mortgage. The options are endless and it’s like buying an expensive suit: it needs to be tailored to fit you.

The moral of the story? Stay calm and carry on. Buying a house marks an exciting chapter in your life and try not to get too bogged down in the paperwork. Do your research, ask questions, and make an informed choice. Plus, remember that your term expires at some point, and you can make changes when that time comes.

Article comments

ann mathews says:

This article seems to be very informative. i have a doubt here , you mentioned that its alright to payoff the mortgage early and if wanted can invest the extra cash too . But will there be any mortgage penalities? https://www.google.ca/searc

Lisa Jackson says:

Hi Ann,

Yes, there could be penalties for paying off your mortgage earlier. It depends on the mortgage agreement with the lender. You would also have to crunch the numbers to determine whether the costs outweigh the benefits. So if the penalty is $15,000, but you’ll pay more in interest keeping the mortgage, it may make sense to pay it off sooner.

If you’re not sure what to do, talk to your lender and get them to do the math.

Good luck!

eldho james says:

well that was a very informative post

Mo says:

I worked for CIBC in the 80s. Mtge rates topped out at 21.46 per cent! This was a nightmare time for some homeowners. When rates are low and you want to sleep at night, go fixed for as long a term as you can get!

John McKay says:

Great article for those shopping for a mortgage. Maybe it takes a bit of the stress out of the whole deal. I did things wrong the first time around, I just went to the bank and did what old Pops said ….. I ended up with a lousy rate for 5 years. Eventually I changed, I renewed with a variable ……… and renewed again. It is true that history proves that variable rate mortgages outperform fixed rate. I’ve seen my rates adjusted up and over, (pain) and then eventually back to even. Variables are great when they are low and they are stressful when they go up. I checked in with a few brokers, didn’t like them at all. I chose an agent and did a DIY mortgage, best choice by far. What I found is that everyone is unique, just because you have a mortgage doesn’t mean that you’ll get the lowest rates. In my case, I wanted the best rate and numerous firms told me that if you want that rate you must have a minimum mortgage of over 250K. Some of the firms wanted a minimum time frame for the maturity as well. There were quite a few differences. The best choice for me was a DIY mortgage (an agent) rather than a broker or bank. I put my information out there and had about 20 or more seriously competitive offers, I shortlisted and chose the best one for me and my situation. I locked in for 5 because the rate was so low I felt good about it. (I’ve got to tell you though, I damn near went variable but instead made the low stress choice, my stomach is happier). It’s hard to predict the future and I can say that in my opinion it is a must to have the mortgage open, don’t let others control you ! I have made a few lump sum payments here and there, I’ve added a little extra here and there . Over time this is well worth it. When in doubt, consider a short term, just don’t give in to the bank like I did when I was young & stupid. Banks are the worst place to get a mortgage.

Leonie says:

Athough the Variable rate is loosely based on the BoC rates, the bank do move their Prime rates independently. That is how they do not pass on full BoC rate drops. I got caught in the Dec 2016 TD .15%rate rise, for no reason. Mortgage rule change used as excuse, but other banks did not follow suit. This only affected customers stuck in their 5 year term. TD will advertise a greater discount under their prime to new customers to remain competitive with other banks. The mortgage rule change did not apply to established mortgages. Pure money grab. Variable rate is actually “let the bank charge whatever they like” rate, until it is cheaper to refinance. It is really based on your banks integrity, and what they can get away with. Agree that Variable is cheaper in the long term, but bank intergrity is factor as well as rate when choosing lender.

Kyle says:

Hi Leonie – while it’s true that rates do move independently, if you have a perfectly competitive market they should move in tandem with the BoC rate. Unfortunately you just highlighted the fact Canada’s system can be a less than competitive market at times (to say the least). I think most businesses will get away with what they can when it comes to profit margin. Usually the market will balance out quickly because obviously as a dissatisfied customer you will not go back right? This is also another argument for 1-year variable agreements!

Leonie says:

Hi, The Fixed rate is different to the variable because it is based on long term bond rates. It is not based on the overnight lending rate or related to the variable ate in any way. Definitely not a premium charged on variable by the bank.

Kyle says:

This is both true and not true Leonie. The fixed rate depends on several things. Yes, the long-term bond rate does affect it, but that’s because the bond rate is indicative of what a bank will be paying out and taking in, in terms of cashflow – and consequently the profit margin! There is most definitely a premium attached to taking a fixed rate vs a variable rate. Also, long-term bond rates are heavily dependent on the BoC’s rate amongst other things, so to say they are not related to the variable rate is not quite true. It’s more the like one does not cause the other, but because similar factors affect both there is a high correlation.

Claudia says:

Hello, I own a house but bought a condo that will be ready in about 18 months from now, the catch is, I need to renew my mortgage now (I have to live somewhere for 18 months :)), the bank where I have my current mortgage is offering me 2.35% on a closed variable 5 year term mortgage, they say that even if I break the mortgage within 12-18 months, the only penalty will be 3 months, is this correct?, I would very much appreciate any insight on this, thank you!!,

Red says:

Super helpful; both original, comments and reply alike, however, I see not one date anywhere and therefore am simply wondering how up to date these rates are. As per my recent rate reviews, they look recent but could you please advise? Much appreciated still since my current mortgage, which is due to be renewed, is with RBC and my main bank is with a Credit Union. We’lol see where this goes…

Kyle says:

They are within the last couple years and pretty up to date Red. My bet is on your Credit Union? Have you checked out our free ebook on housing? It has some great advice on how to negotiate rates and where to find the best ones: https://stg.youngandthrifty.ca/buying-a-house-in-canada/

Dany Sewell says:

With a fixed rate mortgage, the mortgage rate and payment you make each month will stay constant for the term of your mortgage. With a variable rate mortgage, however, the mortgage rate will change with the prime lending rate as set by your lender.
Fixed mortgage rates eases budgeting anxiety and offers stability. But then if the difference between the variable and fixed rate is significant, it may not be worth paying a premium for the stability protection of a fixed rate. On the other hand variable rates have proven to be less expensive over time.
Open mortgages allow you to prepay any amount of your mortgage at any time without a compensation charge. You can also make additional payments without penalties. Open Mortgage terms range from 6 months to 5 years and can have variable or fixed interest rates. Closed mortgages have a prepayment limit, which means you are only permitted to pay 15% of the original principal balance of the mortgage per calendar year. If you elect to pay more than 15% within a single calendar year, compensation charges will apply. To reduce the penalties you can discuss with your mortgage brokers. This type of mortgage is more stable due to its restrictive nature, which is why interest rates are lower than they are for open mortgages.

Pam says:

Thanks for explaining what all the different types of loans are as I recently talked with a lender and was totally lost. I am leaning towards getting a fixed rate mortgage right now but I just don’t know if I will qualify and still get a decent rate.


Fixed Rate Bonds says:

I think it is useful to hear about fixed and variable rate mortgages from yourself as you explain things in simple terms, without all of the unnecessary marketing garb that so many companies use. I really like the fixed rate nature of most investments, be it mortgages or bonds as i can easily budget then but what is actually best in the long term i believe is impossible to be sure.

Simple in France says:

I really don’t find fixed interest rates to be a rip off. Regardless of what interest rates do in Canada or elsewhere, I see interest as a way for banks to not lose money through inflation when they lend to you–inflation in my opinion is bound to beat interest rates in the next 10 years. The housing market can’t crash that much more. . .can it?

I would want to have a fix interest rate on any mortgage I took out because I would want to be absolutely sure how much I was going to pay–and that I can afford it. But . . .I really don’t like risk. It’s not always my investing strong point–however, in the past couple of years, that has served me well.

young says:

Thanks for visiting, simple life. Yeah part of me isn’t good with risk either and part of me wanted to go fixed.. I think if it were my own mortgage instead of one with my boyfirend I might go fixed 🙂

Guy G. says:

I haven’t been in on the variable vs Fixed debate in a while. We’ve been focusing on helping our clients and readers with tips on budgeting to reduce costs. I guess saving on mortgages does tie in a fair bit.

Just wondering if you heard that the Royal Bank raised it’s rates today. Don’t you think the others will follow suit and that this is one of many rate increases?

young says:

@Guy G. Yup! Heard that RBC raised their rates. Yup, I think that others will probably follow suit… I hear that at the credit unions, you can still get some good rates, like 3.69% for a 5 year fixed. I guess it’d be helpful to a) negotiate like mad or b) try and find a mortgage broker…

@chantl01 PRIME -0.7% that’s awesome!! Wow you were probably paying like.. 1.5% interest- crazy! That’s the strategy that I plan to use. That’s amazing that you reduced the amortization from 20 to 8!! You’ll be debt free in 8 years! Congrats!

chantl01 says:

Thanks to the advice of a wise friend who also happens to be a mortgage broker, I lucked in to an open variable mortgage at Prime -0.7% in the summer of 2008. Immediately after which the prime rate started plummeting, yay for me! I’m sticking with the variable rate and paying more than if I had a fixed 5 year rate, plus throwing the odd lump sum at it. I’ve already reduce the amortization from 20 to 8 years and figure I’ll get it close to paid off before the rates ever get close to what they were as fixed rates when I signed.

This is a great post. I want to get into Real Estate but I don

Larimerboy says:

Good stuff for all the young and thrifty out there.

When I bought my place I was one of those sub-prime mortgage people! 5% down, Interest only mortgage 10yr-ARM (YIKES!)…. I learned my lesson and was lucky enough to refinance and get a fixed-rate 30 year at a touch over 5%. There is something very nice about knowing what my payment will be each month for as long as I own the house. I make additional payments to payoff the principle but am thrilled to be out of the Variable Rate Business.

young says:

@Investing Newbie Great! I have a post scheduled for Wednesday that talks about Variable vs Fixed =) The Open Fixed Rate doesn’t have that long of a term (usually 6 months to 1 year) and the interest is MUCH higher than a closed fixed rate. For example, at CIBC (a bank from Canada) the open fixed rate is currently 6.45-6.70%. With a 5 year fixed rate, you could get something as low as 3.80%. I guess it’s okay if you plan to flip the house and you think that the real estate market is going to pop within short term. =) (pop as in go higher, not housing bubble burst!)

@Larimerboy Wow, how did you sleep at night? =) It’s kind of funny (or rather, scary) how people can just approve you just *like that* (I was snapping my fingers) without really checking if you can truly afford something- it’s like you almost need to tell yourself what you feel comfortable with, otherwise, the bank will just max you out. Glad that you’re feeling more comfortable now- it’s nice to know what you have to pay each payment. =)

@Young & Thrifty – We picked a closed mortgage (unfortunately) a few years back. We did so because my wife wanted the security against rising interest rates, although I was more than willing to watch the rates… Oh well. “They” (the experts (economists)) said interest rates were going to rise. That was in 2007. Here we are, spring 2010, just on the cusp of that reality. We’ve paid more than we should have in mortgage interest, but we’ve been able to actively budget around that fixed payment as well, making lump-sum mortgage payments on top of our regular payment, so all is not lost 🙂 Nice post!

young says:

@Financial Cents- That’s good that you’ve been able to make lump sum mortgage payments- it helps chop away at that beast. Thanks for sharing your mortgage choice! =)