TL;DR: Fixed rates are (usually) higher than variable rates. Fixed rates don't change during the term. A variable rate will change with the Prime Rate, which means so could your payment.

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There are two different rate options for home buyers when it comes to mortgages. A fixed-rate mortgage is one that does not change over the term of the mortgage. However, a variable rate mortgage is one where the rate changes when the prime lending changes. A variable rate is expressed as "Prime +/- __". For example, Prime -0.50%. 

Mortgage rates compared

The difference between fixed and variable rates can be seen as one of insurance against interest rates. Often, fixed rates are higher than the variable rate, but the choice to pay more also comes with certainty for the entire length of the term (from 6 months up to 10 years). Fixed rates are best when interest rates are low, particularly if there is no indication they are going to fall further.

If rates are expected to fall, a variable rate mortgage would be the better choice. This will ensure your rate falls when interest rates drop. Paying extra to secure a fixed-rate might not be worth it if there is a big difference between the two rates right from the start, AND if the Prime rate is expected to fall. 

As a starting point, look for a difference of 0.50% or more. For a variable rate to even be worth consideration, it should be at least 0.50% lower than fixed rates. At the time this was written (August 2019) variable rates were HIGHER than 5 year fixed rates, which happens extremely rarely.

Fixed mortgage rates are more common than variable rates with about 66 percent of mortgages being a fixed rate. Variable rates are more common with older home buyers while younger buyers prefer fixed rates. 

Fixed mortgage rate

The interest rate and payment for these mortgages are fixed. The benefits are that you don’t need to be concerned about falling or rising rates. This helps when it comes to budgeting. The drawback is if rates fall, your payment and the amount of interest you pay do not.

Variable mortgage rate

This rate changes with changes in the Prime interest rate. The discount/premium to Prime (the +/- part) that you got when you signed up for your mortgage does not change for the entire term, but the Prime part of the equation can and probably will change at some point. So if you have Prime - 0.50% and the Prime rate is at 3.95%, your rate will be 3.45%. If the Prime rate decreases by 0.50%, then your rate will be 3.45% - 0.50% or 2.95%. Likewise, if Prime increases by 0.50%, your rate would be 3.95%.

Variable-rate mortgages are often less expensive in the long run. The drawback is the uncertainty when it comes to payments and can lead to high payments if the Prime rate increases. 

How rates are determined

Fixed mortgage rates are related directly to Canada Bond Yields where they are impacted by employment levels, exports, and inflation. These factors also influence the Prime rate (which affects variable mortgages) but not always in the same way. Monitoring the yield of the 5 year Canada Bond is a very good predictor of the direction of fixed mortgage rates.

The Prime rate is set by the Bank of Canada, whose stated goal is to manage inflation. Factors like unemployment, exports, and manufacturing will impact the inflation rate. Essentially, when inflation is up the Bank of Canada often decides to increase the Prime rate. This makes borrowing money more expensive. Alternatively, when inflation is low the Bank of Canada will decrease the Prime rate. The aim is to attract borrowers to take money out, which, in turn, should boost the economy. 

When it comes to lenders, the discount or premium on the Prime rate is impacted by factors like marketing strategy, general credit market conditions, competition and the desired market share. These factors also impact the lenders’ fixed mortgage rates and bond yields. 

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