Fixed Mortgage Rate in Canada: Stability and Predictability

RefinancePro.club

The Fixed Mortgage Rate: Stability and Predictability for Your Loan

The fixed mortgage rate is the most common choice among Canadian borrowers, and for good reason: it guarantees that the interest rate will not change for the entire duration of the term. Whether rates rise or fall in the financial markets, your mortgage payment remains identical from the first to the last month of the term. This predictability makes it the preferred option for families, first-time buyers, and anyone who wants to plan their budget with certainty.

How Is the Fixed Rate Determined?

Contrary to popular belief, the fixed mortgage rate is not directly linked to the Bank of Canada's policy rate. It is instead determined by the bond market, specifically by the yield on Government of Canada bonds of equivalent duration. Thus, the 5-year fixed rate moves in line with the yield on the 5-year Government of Canada bond. The lender adds a profit margin (spread) to this yield that reflects its operating costs, credit risk, and market competition. This is why the fixed rate can decrease even when the policy rate remains stable, or vice versa.

Fixed mortgage rate: An interest rate that remains constant throughout the chosen mortgage term, regardless of market fluctuations. The monthly principal and interest payment is identical from beginning to end of the term, providing complete budget predictability for the borrower.

Advantages and Disadvantages of the Fixed Rate

Advantage: stable and predictable payments throughout the term, facilitating family budget planning.
Advantage: complete protection against interest rate increases during the term.
Advantage: peace of mind with no surprises related to economic fluctuations.
Disadvantage: the initial rate is generally higher than the variable rate, as it includes a premium for the stability guarantee.
Disadvantage: the prepayment penalty is higher (IRD vs. three months' interest), making contract breaking more costly.
Disadvantage: if rates decrease during the term, the borrower does not benefit from the reduction without refinancing.

When to Consider selecting a Fixed Rate

A fixed rate is particularly appropriate in several situations. If you are a first-time buyer with a tight budget where every dollar counts, the predictability of a fixed rate eliminates the risk of unexpected increases. If interest rates are at historically low levels, locking in a fixed rate allows you to benefit from these favorable conditions for the entire term. If economic indicators suggest a period of rising rates, a fixed rate protects you. Finally, if you have a low tolerance for financial risk and prefer certainty over uncertainty, a fixed rate is the natural choice.

The Prepayment Penalty: A Determining Factor

One of the most important aspects to consider with a fixed rate is the prepayment penalty. If you need to break your mortgage before the end of the term, for example to sell, refinance, or switch lenders, the penalty on a fixed-rate mortgage is the greater of three months' interest and the interest rate differential (IRD). The IRD can represent very significant amounts, especially if rates have dropped significantly since signing and several years remain on the term. This is why it is crucial to properly evaluate your horizon before choosing a long fixed term. If you anticipate a move, a separation, or any event likely to require a mortgage break, a shorter term or a variable rate could prove more economical.

Frequently Asked Questions

How is the fixed mortgage rate determined in Canada?

The fixed rate is primarily determined by the yield on Government of Canada bonds of equivalent duration. For example, the 5-year fixed rate is influenced by the 5-year Canadian bond. The lender adds a profit margin (spread) to the bond yield to establish its rate. This is why the fixed rate can move independently of the Bank of Canada's policy rate.

What are the advantages of a fixed rate compared to a variable rate?

A fixed rate offers complete payment stability throughout the term, facilitating budget planning. It protects the borrower against interest rate increases. The borrower knows the exact cost of their loan for the term's duration. It is particularly suited for borrowers with a tight budget or low risk tolerance.

What is the penalty for breaking a fixed-rate mortgage in Canada?

The penalty is the greater of three months' interest and the interest rate differential (IRD). The IRD compares your contractual rate to the lender's current rate for a term matching the remaining duration. This penalty can be substantial, especially if rates have dropped since you signed and several years remain on the term.

Is the fixed rate always higher than the variable rate?

Historically, the fixed rate is generally higher than the variable rate at the time of signing, as it includes a risk premium for the guaranteed stability. However, in certain economic conditions, notably during an inverted yield curve, the variable rate may temporarily exceed the fixed rate.

What fixed term is most popular in Canada?

The 5-year fixed term is the most popular in Canada, chosen by the majority of borrowers. It offers a good balance between stability and flexibility. However, shorter terms (1, 2, or 3 years) may be advantageous when rate decreases are anticipated, and longer terms (7 or 10 years) suit borrowers seeking maximum stability.

When should I consider selecting a fixed rate over a variable rate?

A fixed rate is generally recommended if you have a tight budget and cannot absorb payment increases, if rates are historically low, if you anticipate rate increases during your term, or if you prefer the peace of mind of predictable payments. An AMF-certified mortgage broker in Quebec can help evaluate your situation.