The Ultimate Guide to 5-Year Variable Mortgage Rates in Canada

The Ultimate Guide to 5-Year Variable Mortgage Rates in Canada

If you are looking for new mortgage rates, 5-year variable rate mortgages are a great choice. Read on to learn more.

Definition of a 5-year Variable Rate Mortgage

A variable mortgage rate also referred to as the ‘prime rate’, varies with the market rate of interest and is often quoted as prime minus or plus a percentage amount. For instance, a variable rate of interest may be stated as prime + 0.8%. Therefore, when the prime interest rate is 6%, you will be paying 6.8% (6% + 0.8%) interest.

The term, which in cases of 5-year variable mortgages is 5 years, is the period of time a borrower is bound to a variable rate of interest and, at times, also the mortgage payments. With a variable interest rate mortgage, your payments may be established in either one of the two ways. The first is a fixed payment, along with the interest element fluctuating while the second is a fixed sum that is applied to your principal and the varying interest element, which changes the overall volume of the mortgage payment.

For instance, in the first case, if your interest rate drops, a higher amount of your mortgage payment will be applied to lower your outstanding principal however, the aggregate outlay will remain the same. It is important to avoid confusing the term of your mortgage with its amortization period. Amortization term is the length of time you are required to repay the mortgage. Therefore, in the above example, if your outstanding principal is wiped off more quickly due to the drop in interest rate, your amortization period will reduce too.

The popularity of Five Year Variable Rate Mortgages

Even though fixed rate mortgages constitute a higher portion of total mortgages (66%) and are therefore more popular, the remaining 29%, a significant minority, have either variable or adjustable interest rates. Fixed rate mortgages are slightly more popular among the younger age groups; in contrast, older age groups tend to prefer variable rate mortgages.

The term of five years is easily the most popular duration and it seems logical as five years happens to be the median between all the available terms that range from one year to ten years.

Comparison of 5-year Variable Rate Mortgages

Variable rate mortgage exposes a borrower to variations in the rates of interest and, consequently, in the mortgage payments. In case market interest rates change, you will incur the difference in interest rates that apply to the mortgage principal. In addition, if the mortgage payments are structured in a manner that requires you to pay a set or predetermined sum each month, with changes in interest rate altering your principal and interest portions, then the mortgage payment schedule can also change.

In contrast, variable rate mortgages are often more economical compared to mortgages with fixed interest rates and this has been proved with a historical examination. Variable rate mortgages make particular sense in situations where interest rates are declining.

A term of three years is more sensible if you intend to split the mortgage within a couple of years, such as when you are looking to upgrade your house, for example. Choosing a term of three years over five years may end up saving you a significant sum in penalty costs. You should also consider another factor, which is the relationship of the variable rate to the prime rate. In cases where you anticipate that discounts to the prime rate will be more favourable in the short run, going with a 3-year mortgage over a 5-year mortgage may also be a sound financial strategy.

What can Trigger a Change in 5-year Variable Rate Mortgages?

As stated, the interest rate of a 5-year variable mortgage can change with fluctuations in the primary lending rate of interest, which is the interest rate at which most banks lend money to their best and top credit-worthy clients. The variable mortgage interest rate is usually quoted as prime minus/plus a specific percentage of premium or discount.

This variable interest rate mortgage often changes with short-term rates of interest and can also help save you a considerable amount of money over the term of the mortgage. Variable rate mortgages are of two types: closed and open.

A closed variable rate over 5 years will bind you to the terms and conditions of the mortgage for a period of five years. In contrast, an open variable rate will give you the flexibility and convenience to switch to a fixed interest rate at any point in time, but in this case interest rates tend to be higher.

How Variable Rate Interest Mortgages Work?

Variable rate mortgages are typically expressed in terms of the prime lending interest rate, which is quoted by banks, minus or plus a fixed percentage depending on the applicable credit terms and conditions. For instance, a variable rate mortgage marketed as ‘prime plus 0.5,’ means that the rate of interest will be the rate that is posted as the prime rate reduced by half a percent. So, if the prime rate is 4%, the variable interest rate will be 4.5%.

The prime lending rate in Canada fluctuates in conjunction with the overnight rate quoted by the Bank of Canada. Therefore, if the bank minimizes or increases its lending interest rate, your variable rate mortgage will move down or up by the exact same amount in a couple of days.

Calculating Payments with Variable Rate Mortgages

With variable rate mortgage products, you can calculate your payments in two ways:

  1. If you pay a fixed sum every month, then the portion of the interest you pay changes on the basis of the rate of interest prevalent at that time. You may take advantage of declining interest rates and repay a higher amount of the principal while making a constant payment.
  2. If you pay a specific amount of interest and principal, then the sum you repay every month will move up or down with the change in interest rates.