Should you switch from a variable-rate to a fixed-rate mortgage?

This post was first published on October 3, 2022, and was updated on September 5, 2023.

Interest rates have surged over the last year and a half; the Bank of Canada hiked rates a historic nine times between March 2022 and July 2023, bringing the benchmark cost of borrowing to 5%; a full 4.75% higher than where it sat during the pandemic years, when policymakers kept it at a record-low 0.25% in order to protect the economy.

That’s resulted in the Prime rate – which lenders use when pricing their variable-rate borrowing products – rising to 7.2%, and today’s lowest five-year variable mortgage rate increasing to 6.05% – a far cry from the 0.89% one could qualify for back in 2021! In fact, today’s lowest variable mortgage rate is higher than the lowest fixed-rate option – a rare anomaly, as historically, variable rates are almost always the cheaper choice. And, given inflation remains historically elevated – the main factor behind the Bank of Canada’s hiking cycle – it’s highly unlikely rates will return to those pandemic-era lows… At least, not any time soon.

All this means is that today’s mortgage borrowers are grappling with a dramatically higher interest rate environment than they have in decades. For variable-rate holders, that poses the question: is now the time to switch to a fixed-rate mortgage? 

Let’s take a look at the ins and outs of switching from a variable-rate to a fixed-rate mortgage.

Also read: Should I pay down my mortgage with a lump sum, or invest?

What’s the difference between a variable-rate and fixed-rate mortgage?

When you get a mortgage, you have the opportunity to decide between a fixed mortgage rate and a variable mortgage rate.

When you get a fixed-rate mortgage, your interest rate is locked in for your entire mortgage term. Fixed mortgage rates tend to be higher at initiation, but are guaranteed not to change. You’ll have the same payment for the duration of your term, and, as long as you make your payments on time, you’ll know exactly how much you’ll still owe when it’s time to renew.

When you get a variable-rate mortgage, your interest rate can change over the term of your mortgage. When the lender’s prime rate changes, your mortgage rate changes by the same amount. Depending on how your mortgage is set up, your payment may change to reflect the revised interest rate, or you can keep the same payment by adjusting the proportion of it that goes toward paying down your balance.

Why would I want to switch from a variable-rate mortgage to a fixed-rate mortgage?

Interest rates are rising faster than they have in the last 20 years. If you have a variable-rate mortgage, the rate you’re paying today is 390 basis points (bps) higher than you were paying this time last year. That works out to an extra $3,900 per year for every $100,000 you’ve borrowed.

Experts are speculating that interest rates could rise another 25 basis points by the end of 2023. On a $500,000 mortgage balance, you could be spending $145 per month more on interest by December 2023 than in May, and a whopping $1,202 than you would have back in January 2022.

Due to this, demand for variable-rate mortgages has plummeted so far in 2023; a recent study from Ratehub.ca finds inquiries for variable rates made up only 5% of all such user submissions in the first five months of the year, compared to 26% in 2022.

One option to stop this trend of rising costs is to switch from a variable-rate mortgage to a fixed-rate mortgage and lock in an interest rate that’s guaranteed not to change for the entirety of your term, with five years being the most popular term length. 

I think I want to lock in a mortgage rate. What are my options?

If you’re worried about rising interest rates, there are generally three options for borrowers when it comes to your mortgage. Depending on your mortgage product and the terms available at your lender, you may be able to convert your existing mortgage from variable to fixed; refinance your mortgage to one that better meets your needs; or continue on with your existing mortgage. Note that not all lenders have all terms available and depending on your product, there may be more restrictive or specific terms and conditions.

Each option has pros and cons and the right choice for you depends on your situation. Be sure to discuss your potential options with your lender to determine what may be possible in your specific situation.

Option 1: Convert your existing mortgage from variable to fixed

The first option is to stay with your current lender and convert from a variable mortgage rate to a fixed one. This can usually be done with a phone call and without triggering any penalties.

The downside, however, is that you will have to lock in to your lender’s posted rate for the remainder of the term. For example, if you took out a 5-year variable-rate mortgage two years ago and wanted to switch to a fixed-rate mortgage today, you would pay your lender’s posted rate for a 3-year fixed-rate mortgage. That posted rate is currently 6.4%, which is probably much higher than the rate you’re already paying.

Option 2: Refinance your mortgage to one that better meets your needs

Your second option is to refinance your mortgage entirely. This involves breaking your current mortgage and taking out an entirely new one, which leaves you free to shop around. You can get any mortgage from any lender and choose the rate and terms that work for you.

 This method may be preferable to sticking with your existing lender but comes at a cost. In addition to a pre-payment penalty of three months’ simple interest, you’ll also be saddled with your lender’s fees for discharging the mortgage. Further, you’ll need to hire a real estate lawyer to complete the transaction. And that’s all assuming you qualify for the new mortgage you want.

Option 3: Continue on with your existing mortgage

 Your third option is to keep on with the mortgage you already have. You may find that none of the other options are worthwhile and that you’re most likely to come out ahead by doing nothing.

If you do carry on as you are, you could find your mortgage rate continues to rise and the options for converting to a fixed-rate mortgage may not be as good as the choices you have now.

How do I decide which option is right for me?

Deciding which option is right for you depends on a few things, including whether interest rates will continue to rise in the future, whether you’re prepared to take that risk, and what you need from your mortgage.

Let’s compare all three options, assuming you currently have a variable-rate mortgage with a rate of Prime minus 1.15%, which comes to 5.8%), fixed payments of $3,102 per month, a balance of $500,000, three years remaining in your term, and a remaining amortization of 23 years.

Please note that this is an example only; not all lenders have all terms available and depending on your product, there may be more restrictive or specific terms and conditions.

Assuming rates will rise by 0.25% once more by the end of 2023, let’s use Ratehub’s mortgage payment calculator to consider how your payments could change based on whether you convert, refinance, or stick with your existing rate.

Scenario: Rates rise to 6.05% by the end of 2023

Let’s compare your three options based on the assumption that rates will rise twice more, bringing the Bank of Canada’s Overnight Lending Rate to 5.00%, and the best five-year variable mortgage rate to  6.05%.

If you choose to convert your existing mortgage, you’ll lock in to a 3-year fixed rate of 6.4%.

If you choose to refinance, you’ll be able to get the best 3-year fixed mortgage rate in Canada of 5.09% at a cost of approximately $8,367 in penalties and fees. [Note: This assumes a pre-payment penalty of approximately $7,017 (three months’ simple interest), a discharge fee of $350, and lawyer fees of $1,000.]

And if you choose to keep your mortgage, you’ll see your interest rate rise from 5.8% to 6.05% over the coming year.

In this scenario, you’ll save the most money in the short term by refinancing to the best three-year fixed mortgage rate of 5.09%. You’ll pay $277 less per month by doing so than if you stayed in your current rate, which rose to 6.05%. You’ll also pay $13,818 less in interest over the three-year time period.

What else do I need to know about switching from a variable-rate to fixed mortgage?

There are a few things to keep in mind if you’re thinking about switching your variable-rate mortgage to a fixed rate one:

• Switching from variable to fixed is easy. Switching from fixed to variable is hard. If you switch to a fixed-rate mortgage, it might not be so easy to switch back. The penalty for breaking a fixed-rate mortgage can be much higher than the penalty for breaking a variable-rate mortgage, especially when mortgage rates are going down.

• Refinancing requires you to pass the stress test. To refinance your mortgage, you’ll need to qualify at a rate of at least 2% higher than what’s in your contract. If you don’t qualify for a new mortgage, you’ll be forced to stay with your old lender. For that reason, you may want to consider refinancing sooner than later if you believe mortgage rates will continue to rise.
• Falling property values also affect mortgage affordability. In most cases, you can only take out up to 80% of the value of your home when you refinance. If your property value has fallen to the point where you can’t access enough equity to pay off your existing mortgage, refinancing will be a challenge.
• Your monthly payment doesn’t tell the whole story. While cash flow is important, the amount of interest you pay is what makes your mortgage expensive. Make sure you’re taking the cost of borrowing into account, as well as the length of time it will take you to pay off your mortgage.
   

How can I go about switching my variable-rate mortgage to a fixed-rate mortgage?

If you’re still thinking about switching from a variable-rate mortgage to a fixed-rate mortgage, there are a few steps to take.

1. Get in touch with your current mortgage lender. Let them know you’re thinking about making the switch and find out what your mortgage would look like. Be sure to ask about the monthly payment, interest rate and total cost of borrowing. Use the opportunity to ask about the cost of breaking your mortgage including any fees.
2. Speak with a mortgage broker. A mortgage broker can help you understand your options and decide whether refinancing makes sense for you. They can also help you get pre-approved for a new mortgage and give you a clear picture of what you qualify for.
3. Consider your needs. Give some thought to what’s important to you in a mortgage. Are you willing to make higher payments in exchange for better outcomes later on? How much would you need to save in interest to make refinancing worthwhile? Will you regret locking in a fixed rate if it ends up costing you more in the long run?
4. Make the call. While it’s impossible to make this decision with perfect information, use what you know to make an informed decision and take action. Work with your lender or mortgage broker to make the changes you need to ensure your mortgage works for you.
   
   

The bottom line

Locking in a fixed mortgage rate can help bring stability in a time of rising interest rates, but the best choice for you depends on your unique situation and your appetite for risk. You may decide that the peace of mind a fixed-rate mortgage and its stability give you are worth paying a little extra. Work with your lender and a mortgage broker to gather as much information as you can, and carefully weigh your needs and options before making a decision.

Also read: 

• Bank of Canada hikes target rate to 4.75% in June announcement
• Mortgage borrowers could see payments soar 25% at renewal time
• Demand for variable mortgage rates down 21% compared to 2022
• The Trigger Rate: Everything You Need to Know
• How Does the Rising Stress Test Impact Mortgage Affordability?