Fixed vs Variable Mortgage: How to Compare Offers

Fixed vs variable: how to compare two mortgage offers fairly

Option A

5.19%

Interest: $122,947

Option B

4.19%

Interest: $98,488

From the worked example “Stress test: the variable rate one point higher”. $500,000 variable-rate mortgage, 25-year amortization, monthly compounding, with the payment recalculated at the higher rate for the whole five-year term; an illustrative stress case, not a forecast.

A fixed rate and a variable rate are not two prices for the same product. A fixed rate stays the same for the term; a variable rate moves with the lender's prime rate. They are priced off different market rates, they usually compound differently, and they put different risks on your household budget. Putting a fixed quote next to a variable quote and picking the lower number skips most of what matters. Here is a fairer way to line them up.

Mitey: “Grade each offer against its own yardstick before you put them side by side.”

Different products, different yardsticks

Fixed and variable rates answer to different parts of the market. Fixed mortgage pricing tends to move with Government of Canada bond yields for a similar term. Variable rates are set as a spread from the lender's prime rate, and each institution sets its own prime as a function of its funding cost, which is influenced by the Bank of Canada's target for the overnight rate.

That is why the checker never compares a variable quote with a fixed benchmark, or the other way round. Each one is scored against the Bank of Canada's effective rate on comparable new lending:

Fixed offers: the effective rate on new insured or uninsured fixed mortgages for the same term bucket, moved by the change in the matching Government of Canada yield since that month (labelled as an estimate).
Variable offers: the effective rate on new insured or uninsured variable-rate mortgages, moved by any policy-rate change since that month (also labelled as an estimate).

Step one: grade each offer on its own terms

In this example an illustrative fixed offer of 4.69% gets a mark of 73 out of 100 ("grade C"), 0.35% above a fixed benchmark of 4.34%. An illustrative variable offer of 4.19% gets a mark of 63 ("grade D"), 0.54% above a variable benchmark of 3.65%.

Those two scores tell you whether each lender is pricing its product competitively for what it is. They do not tell you which product suits you. That depends on how comfortable you are with a payment or interest cost that can change during the term. Run your own quotes through the fixed checker and the variable checker.

Worked exampleGrading an illustrative five-year fixed offer

Rate: 4.69%
Score: 73
Verdict: grade C
grade: C
Benchmark: 4.34%
typical: 4.83%
Gap: 0.35%
Direction: above
Cost vs benchmark: $8,382

Assumptions: A $500,000 uninsured five-year fixed mortgage with a 25-year amortization, graded against the lowest published rate in Ontario at this page's last update. Computed by the site's calculators.

Step two: compare like with like on payment and interest

Compounding matters at the margin. The Interest Act requires a blended-payment mortgage to state its rate calculated yearly or half-yearly, not in advance. In practice Canadian fixed-rate mortgages quote rates compounded semi-annually, while variable-rate mortgages commonly compound monthly. At the same quoted rate, monthly compounding costs slightly more. Our guide to Canadian mortgage compounding explains the conversion.

The table puts the two illustrative offers on the same $500,000 balance for the first year, assuming the variable rate does not move. That last assumption is the one to keep in mind.

First year on $500,000 with a 25-year amortization (illustrative rates)
	Fixed offer	Variable offer
Quoted rate	4.69%	4.19%
Compounding	Semi-annual	Monthly
Effective monthly rate	0.39%	0.35%
Monthly payment	$2,820.42	$2,691.92
Interest paid in year one	$22,995	$20,729
Principal repaid in year one	$10,850	$11,574

Step three: stress-test the variable offer

A variable rate's starting gap is only worth something while it lasts. A simple test is to ask what happens if the rate is a full percentage point higher for the whole term. At 5.19% instead of 4.19%, the payment on $500,000 would be $286.65 a month higher and interest over 5 years would rise by $24,459.

This is a stress case, not a forecast; rates can fall as well as rise. The point is to know the number before you sign, and to ask the lender how a prime-rate change would show up for you: whether your payment would change, or whether it would stay level while more of it goes to interest. Our guide to how variable-rate payments work covers both set-ups, and the Financial Consumer Agency of Canada has a page on preparing for rising rates.

Worked exampleStress test: the variable rate one point higher

	At 5.19%	At 4.19%
Monthly payment	$2,978.57	$2,691.92
Interest over 5 years	$122,947	$98,488
Balance after 5 years	$444,233	$436,973

Assumptions: $500,000 variable-rate mortgage, 25-year amortization, monthly compounding, with the payment recalculated at the higher rate for the whole five-year term; an illustrative stress case, not a forecast. Computed by the site's calculators.

Step four: compare the ways out

On a closed mortgage, the penalty for breaking early is usually the higher of three months' interest or an interest rate differential, and lenders usually use the differential when your rate is higher than the current rate and the contract was signed less than five years ago. Your agreement sets out which applies, so ask each lender to explain its method for the specific product it is offering.

How is the prepayment penalty calculated, and which comparison rate would be used?
Can a variable-rate mortgage be converted to a fixed term during the term, and at what rate?
What are the annual prepayment privileges for each offer?
Is the mortgage portable if you move?

Questions people ask

Is a variable rate always lower than a fixed rate?

No. The relationship depends on where bond yields and the policy rate sit, and it changes over time. Compare each offer with its own benchmark, then decide whether the difference is worth the uncertainty.

Why does the checker use a separate benchmark for variable rates?

Because the two are priced off different things. Variable rates follow lenders' prime rates, which respond to the Bank of Canada's policy rate; fixed rates tend to follow Government of Canada bond yields. A single benchmark for both would make one look artificially good and the other artificially poor.

Does monthly compounding make a variable rate more expensive?

Slightly, for the same quoted rate. Monthly compounding adds interest to interest more often than semi-annual compounding does, so 4.19% compounded monthly costs a little more than 4.19% compounded semi-annually would. The difference is small next to a change in the rate itself.

What happens to my variable-rate mortgage when the Bank of Canada changes its rate?

Each lender sets its own prime rate, influenced by the Bank of Canada's target for the overnight rate, and your variable rate is tied to that prime. Ask your lender how and when a prime change flows through to your payment or to the split between interest and principal. See how the Bank of Canada rate affects you.

Can I compare a three-year fixed with a five-year variable?

You can, but check each against its own benchmark first, and remember that a shorter term means renewing sooner at whatever rates apply then. Our guide to mortgage term length covers that trade-off.