Hybrid / Combined Mortgage Rate: Fixed and Variable Split

RefinancePro.club

A hybrid mortgage rate, also known as a combined or split rate, is a product that divides the mortgage into two distinct portions: a fixed-rate portion and a variable-rate portion. This structure allows the borrower to diversify their exposure to rate fluctuations by combining the stability of a fixed rate with the savings potential of a variable rate. In Canada, this option is offered by several financial institutions and is particularly popular among borrowers who do not want to choose exclusively between fixed and variable. The split between the two portions is generally flexible: the borrower can choose to allocate 50% at a fixed rate and 50% at a variable rate, or any other combination according to the lender's policies. In Quebec, each portion is subject to the standard conditions of its respective rate type, including prepayment penalty terms. The fixed portion is subject to the interest rate differential (IRD) calculation, while the variable portion is subject to the three months' interest penalty. The AMF-certified mortgage broker must clearly explain the implications of each portion, particularly regarding renewal and loan portability.

The Hybrid Mortgage: Diversifying Your Rate Exposure

The fixed versus variable rate debate is a classic in Canadian mortgage financing. The hybrid mortgage, also known as a combined or split mortgage, offers an elegant solution for borrowers who do not want to put all their eggs in one basket. By dividing the mortgage into two distinct portions, each with its own rate type, this approach mitigates risk while preserving savings potential.

Structure and Mechanics of the Hybrid Mortgage

The hybrid mortgage divides the total financing amount into two tranches. The first tranche carries a fixed rate for the duration of the term, providing payment predictability. The second tranche carries a variable rate indexed to the lender's prime rate, offering the potential to pay less interest if rates remain stable or decrease. Both tranches share the same term, the same amortization period, and are secured by the same property.

Hybrid mortgage (split mortgage): A mortgage divided into two portions: one at a fixed rate and the other at a variable rate. Both portions share the same term and the same property as collateral, but each is subject to the conditions specific to its rate type, including prepayment penalty terms.

Common Splits and Strategies

50% fixed / 50% variable: a balanced split offering equal exposure to both rate types. A popular option for borrowers who want a simple compromise.
70% fixed / 30% variable: a conservative split that prioritizes stability while retaining a variable portion to benefit from potential rate decreases.
30% fixed / 70% variable: an aggressive split that maximizes the savings potential of the variable while keeping a fixed cushion for predictability.
Custom split: some lenders allow borrowers to freely choose the percentage allocated to each portion, in 10% increments.

Implications for the Prepayment Penalty

One of the lesser-known advantages of a hybrid mortgage relates to the prepayment penalty. If the borrower decides to break the mortgage before term, each portion is calculated according to the rules specific to its rate type. The fixed portion is subject to the greater of three months' interest and the IRD, while the variable portion is limited to three months' interest. As a result, the total penalty on a hybrid mortgage is often significantly lower than on a fully fixed-rate mortgage, providing greater flexibility for the borrower.

Key Points to Verify Before Choosing a Hybrid Mortgage

Loan portability: Verify whether both portions of the mortgage are transferable to a new lender at renewal. Some lenders limit the portability of hybrid mortgages, which could reduce your negotiating power.
Prepayment privilege conditions: Ensure you clearly understand how prepayment privileges apply to each portion. The annual permitted percentage (typically 10% to 20% of the original balance) may apply globally or per portion.
Variable portion conversion: Ask whether the variable portion can be converted to a fixed rate mid-term without penalty. This conversion option provides additional protection if rates increase significantly.

Frequently Asked Questions

How is the fixed-variable split determined in a hybrid mortgage?

The split is generally chosen by the borrower based on options offered by the lender. The most common combinations are 50/50, 60/40, or 70/30 between the fixed and variable portions. Some lenders offer full flexibility in 10% increments, while others offer predefined splits.

What is the prepayment penalty on a hybrid mortgage?

Each portion is treated separately. The fixed-rate portion is subject to the greater of three months' interest and the IRD, while the variable-rate portion is subject to three months' interest only. The total penalty is the sum of both, which often makes it lower than the penalty on a fully fixed-rate mortgage.

Can I change the fixed-variable split during the term?

No, the split is determined at the time of origination or renewal and remains fixed for the entire term. To change the split, it is necessary to wait until renewal or break the mortgage, which triggers penalties.

Is a hybrid mortgage eligible for CMHC insurance?

Yes, a hybrid mortgage can be insured by CMHC as long as it meets the standard eligibility criteria, including the maximum loan-to-value ratio of 95% for a purchase. Both portions of the mortgage are covered under the same mortgage insurance policy.

What are the tax advantages of a hybrid mortgage for a rental property?

For a rental property, mortgage interest is tax-deductible. A hybrid mortgage allows you to deduct interest on both portions. The variable portion may generate interest savings during low-rate periods, optimizing the net after-tax return on investment. Consult an accountant to validate your specific situation.