Fixed-rate mortgages

A fixed-rate mortgage can provide you with security and stability – but compare different lenders and interest rates before applying.

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A fixed-rate mortgage can give you peace of mind by protecting you from interest rate increases. A fixed-rate mortgage also provides you with consistent monthly payments which can help with your personal budgeting – each month, you’ll owe the same amount.

Fixed-rate mortgages are by far the most common type of mortgage in Canada, and can be useful for borrowers who are risk-averse. But before you decide to apply for a fixed-rate mortgage, ensure that you understand the different types of interest rates available and compare a variety of lenders before you apply. Although it might seem easier to apply with your current bank, you may be able to save money by shopping around and comparing rates offered by both online lenders and popular financial institutions.

What is a fixed-rate mortgage?

A fixed-rate mortgage has an interest rate that remains unchanged for the loan term, which means that monthly payments remain the same each month. As the rate is locked in, fluctuations in the market won’t affect your monthly payments. Loan terms generally extend from six months to 10 years, after which you will need to renew your mortgage offer. You can stick with your current lender, who will reach out to you with a new interest rate and loan term, or you can refinance with a different lender and try to score a better deal.

For example, if you took out a mortgage of $400,000 at a fixed-rate of 3.4% interest on a 10 year term amortized over a 25-year period, you would have standard monthly payments of $1,976 for the first 10 years. After the 10 year term is up, your lender could offer you an increased or decreased interest rate depending on market conditions.

Fixed-rate mortgages are available with 5-, 10-, 15-, 20-, 25-, 30- and sometimes 35- year amortization periods. They require a down payment of 5-20%. If you put down a down payment of less than 20%, you will have to pay mortgage insurance, also known as CMHC insurance.

How is fixed-rate interest calculated?

Banks and mortgage lenders will take the prime rate into consideration when setting fixed-rate mortgage rates. They will also take into account competing lenders rates, and economic factors such as inflation, the demand for money throughout the country and stock market levels.

By law, fixed-rate mortgages are compounded semi-annually, or twice a year, and any unpaid mortgage interest is added to the principal amount of the loan.

Pros and cons of a fixed-rate mortgage

Pros

  • Consistent payments. Since the interest rate doesn’t change throughout the loan term, your monthly payments will be the same, which can help with cash flow, budgeting and lifestyle management.
  • Simplicity. Fixed-rate mortgages are generally easier to compare than variable rates, as the math is more straightforward and you don’t have to consider the complex factors associated with variable rates.
  • Protected from rate rises. If you have a fixed-rate mortgage for a long term, say 10 years, and rates increase after a couple of years, then you won’t be at risk of defaulting on your loan due to higher monthly payments. Conversely, if rates fall, then you can refinance if possible.
  • Protected from inflation. Regardless of changes to inflation in the market, your interest rate will remain stable throughout your loan term.

Cons

  • Market risk. You won’t benefit if the interest rate drops.
  • Your term will expire sooner than later. Loan terms on mortgages typically sit between six months to 10 years. Once the term reaches maturity, you’ll need to accept a new interest rate from your current lender – or try to score a better deal with a new lender.
  • Higher rates. Fixed-rate mortgages typically come with higher average introductory interest rates compared to those offered during the initial period for variable rate mortgages.

Who is a fixed-rate mortgage best suited to?

Although this will depend on a myriad of factors and your personal situation, generally fixed-rate mortgages are good when:

  • Current rates are low. If current interest rates are low, it may be a good time to lock in a competitive rate for up to 10 years.
  • You have good credit. The lender will look at your credit score to determine whether you can commit to your monthly payments over an extended period of time.
  • You value stability. Fixed-rate mortgages may be suited for borrowers who are risk-averse and prefer to have stability, certainty and consistency with their monthly payments.
  • You need to budget. By virtue of their fixed monthly payments, fixed-rate mortgages are predictable which helps a borrower create their personal monthly budget.

How does the loan term of a fixed-rate mortgage influence interest and equity?

You can typically lock in a fixed interest rate for a loan term of six months to 10 years.

  • If you choose a shorter loan term, say six months to one year, you can typically score a lower interest rate for that period of time. However, you’ll need to renew your mortgage offer after just six months or a year. The interest rates may have already risen slightly depending on the market. Over the course of your loan term, you’ll have paid slightly more towards the principal amount than you would with a higher interest rate, meaning you’d have a bit more equity in your home.
  • If you choose a longer term of say, 10 years, your interest rate will likely be much higher. This is because lenders likely know that interest rates will be higher 10 years from now, so they charge you more now to make up for any fluctuations in the market. Over the course of your loan term, you’ll have paid more towards interest, less towards your principal amount and ultimately own less equity in your home.

The most common loan term in Canada is a 5 year term with a fixed-rate amortized over 25 years.

How does the amortization period of a fixed-rate mortgage influence interest and equity?

The longer the amortization period of a mortgage, the more interest you’ll pay over the life of the mortgage – but your monthly payments will be lower. Conversely, the shorter the amortization period, the higher your monthly payments will be, but the faster you’ll pay off the mortgage and build equity in your home.

Amortizing your mortgage over 35 years is relatively uncommon. If you don’t put a down payment of at least 20% down on your home, you can’t qualify for an amortization period longer than 25 years.

A 30- or 35- year fixed-rate mortgage may be useful when:

  • You’ve put a down payment of at least 20% on your house.
  • You think you might have an unpredictable income or unstable job.
  • You want low monthly payments and don’t mind paying more in interest over the life of the mortgage.
  • You want to free-up your cash flow and live a comfortable lifestyle.

A 25- year amortization period is the most common in Canada. Although your monthly payments will be higher than with an amortization period of 30 or 35- years, you’ll pay less interest and be able to own your house sooner.

A 25- year fixed-rate mortgage may be useful when:

  • You plan to retire within the next 30 years or less.
  • You want to own your home relatively quickly.
  • You want to have low monthly payments to free-up your cash flow and live comfortably.

Although your monthly payments will be much higher, especially with a 5- year, 10- year or 15- year amortization period, you’ll pay much less overall interest on the mortgage due to the much shorter mortgage length. You’ll also be able to pay off your mortgage sooner and own your house within a few short years.

A 5- year to 20- year amortization period may be useful when:

  • You don’t have a big mortgage to begin with.
  • You don’t have a down payment of 20%.
  • You plan to retire within 20 years or less.
  • You want to own your home quickly.
  • You want to pay less interest.
  • You have a substantial income or low monthly expenses.

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