Fixed vs. Variable Rate Mortgages

Choosing between a fixed and variable interest rate is one of the most significant decisions you will make when getting a mortgage. Both options are legitimate, and the right choice depends on your personal finances, your risk tolerance, and the current interest rate environment. This page explains how each works, what the risks are, and how to think through the decision.

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How Fixed Rate Mortgages Work

With a fixed rate mortgage, your interest rate is locked in for the entire term of your mortgage. The most common term is 5 years, though terms of 1, 2, 3, 4, 7, and even 10 years are available. During your term, your monthly payment stays exactly the same regardless of what happens to interest rates in the broader economy.

Fixed rates are set by lenders based primarily on the Government of Canada bond yields (specifically the 5-year bond for 5-year fixed rates). When bond yields go up, fixed mortgage rates tend to go up, and vice versa.

Advantages of Fixed Rates

• Complete payment predictability — You know exactly what your mortgage payment will be every month for the duration of your term. This makes budgeting straightforward and eliminates surprises.
• Protection from rate increases — If the Bank of Canada raises its overnight rate during your term, your mortgage payment does not change. Borrowers who locked in at 2% in 2020 were protected when rates rose to 5% in 2023.
• Peace of mind — There is real psychological value in knowing your largest monthly expense will not change. For first-time buyers adjusting to homeownership costs, this stability can reduce stress significantly.

Disadvantages of Fixed Rates

• Higher initial rate — Fixed rates are almost always higher than the variable rate available at the same time, because you are paying a premium for certainty.
• Locked in if rates drop — If interest rates fall during your term, you continue paying the higher rate you agreed to. You can only benefit from lower rates by breaking your mortgage, which involves a penalty.
• Expensive to break — The penalty for breaking a fixed-rate mortgage early is the greater of three months’ interest or the Interest Rate Differential (IRD). The IRD can be extremely expensive — sometimes $15,000 to $30,000 or more depending on how much rates have dropped since you signed and how much time remains on your term. This is a critical risk if you think you might need to sell or refinance before your term is up.

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How Variable Rate Mortgages Work

With a variable rate mortgage, your interest rate fluctuates based on the Bank of Canada’s overnight lending rate. When the Bank of Canada changes its key interest rate (typically at one of its eight scheduled announcement dates per year), your mortgage rate adjusts accordingly.

Variable rates are typically expressed as prime rate plus or minus a certain amount. For example, “prime minus 0.50%” means your rate is always 0.50% below your lender’s prime rate. If prime is 5.00%, your rate would be 4.50%. If prime drops to 4.50%, your rate drops to 4.00%.

There are two common structures for variable rate mortgages:

Adjustable-Rate Mortgage (ARM)

Your monthly payment changes each time your rate changes. If rates go up, your payment increases. If rates go down, your payment decreases. You always know exactly how much of each payment goes to principal versus interest.

Variable-Rate Mortgage (VRM)

Your monthly payment stays the same, but the proportion going to interest versus principal changes. When rates rise, more of your fixed payment goes to interest and less to principal. When rates fall, more goes to principal. This structure can create problems if rates rise significantly.

Advantages of Variable Rates

• Historically lower cost — Studies have consistently shown that variable rates cost less than fixed rates over time. A widely cited Bank of Canada study found that borrowers with variable rates saved money in roughly 80% of historical periods compared to fixed-rate borrowers.
• Cheaper to break — The penalty for breaking a variable-rate mortgage early is typically just three months’ interest. On a $400,000 mortgage at 5%, that is about $5,000 — far less than the IRD penalty on a fixed-rate mortgage.
• Immediate benefit from rate cuts — When the Bank of Canada lowers rates, your rate drops at the next adjustment date, often within weeks.

Disadvantages of Variable Rates

• Payment uncertainty — Your costs can increase if the Bank of Canada raises its overnight rate. During the 2022-2023 tightening cycle, variable-rate borrowers saw their effective rates climb from around 1.5% to over 6% in roughly 18 months.
• Trigger rate risk — With a VRM (where your payment is fixed but the rate fluctuates), there is a point called the trigger rate where your fixed payment no longer covers the interest portion of your mortgage. When this happens, your lender may force an increase in your payment or add unpaid interest to your principal (called negative amortization). Thousands of Canadian borrowers hit their trigger rates in 2022-2023.
• Stress and anxiety — Rate changes are widely covered in the news, and the uncertainty can weigh on first-time buyers who are already adjusting to new financial responsibilities.

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Historical Context

Understanding recent history helps put the decision in context:

• 2020-2021: Variable rates were extraordinarily low (some under 1.5%). Borrowers who chose variable saved significantly compared to fixed-rate borrowers during this period.
• 2022-2023: The Bank of Canada raised rates aggressively from 0.25% to 5.00% to combat inflation. Variable-rate borrowers saw their rates more than triple. Many hit trigger rates and faced payment shock.
• 2024-2025: The Bank of Canada began easing rates, providing relief to variable-rate borrowers. Fixed rates also declined as bond yields fell.

This recent cycle illustrates both the upside and the downside of variable rates in dramatic fashion. The borrowers who benefited most from variable rates during this period were those who started variable in 2020, then locked in to a fixed rate in early 2022 before the rate hikes began. The borrowers who were hurt most were those who took variable rates in 2021-2022, just before the sharpest rate increases in decades.

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Which Should You Choose?

There is no universally correct answer. Here is a framework for thinking through the decision:

Consider a fixed rate if:

• You are on a tight budget and cannot absorb payment increases
• You value predictability and sleep better knowing your payment will not change
• Interest rates are at historically low levels (locking in protects you from future increases)
• You are unlikely to sell or break your mortgage before the term ends — use a mortgage calculator to compare your total costs under different scenarios

Consider a variable rate if:

• You have financial flexibility to absorb potential payment increases of 20-30%
• You plan to sell or refinance before the term ends (the lower break penalty is valuable)
• There are strong indications that rates will decline during your term (e.g., the Bank of Canada has signalled rate cuts)
• You are comfortable monitoring rate announcements and adjusting your budget

Tip

Many mortgage brokers recommend that first-time buyers start with a fixed rate for their first term. The predictability helps you adjust to homeownership costs — property taxes, insurance, maintenance, and utilities on top of your mortgage payment — without the added stress of fluctuating payments. Once you have a term of homeownership experience and a better sense of your financial flexibility, you can consider variable when you renew.

Caution

If you choose a variable rate, make sure you understand whether you are getting an ARM (payment changes) or a VRM (payment stays fixed but allocation changes). Ask your lender specifically about your trigger rate — the interest rate at which your fixed payment would no longer cover the interest. Knowing this number in advance lets you plan for the worst case.

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Next: Amortization Periods: 25 vs. 30 Years