Variable Penalties Versus Fixed

There are two main types of interest rates one can have with their mortgage; fixed or variable. A fixed interest rate is locked in and the amount you pay month to month in principal and in interest is pre-determined, regardless of any changes in a bank's prime lending rate. Variable interest rates can change. Typically, they are lower than the fixed rates you would see and are defined as Prime minus or plus X amount. Prime being the prime lending rate and X being whatever number the bank is offering.

At the time of this article, you can get a 3 year fixed interest rate at 2.64%. You can also get a variable interest rate at Prime minus 0.35%. The current prime rate is 2.7% so you would end up with a 2.35% interest rate. The difference between a fixed 2.64% interest rate and 2.35% variable interest rate is approximately $58 a month on a $250,000 mortgage. The downside, if the banks ever raised their prime lending rate, the variable rate would increase but the fixed rate would remain the same.

BUT, there is one more aspect that needs to be considered; penalties. When you break a mortgage early, you pay a penalty. This penalty depends on how much you still have owing, how far into your commitment you are, what your interest is and what the bank or lenders current interest rates now. If you have a variable interest rate you pay a penalty equivalent to 3 months interest. If you have a fixed rate mortgage, it is either 3 months interest or something called the interest rate differential (IRD), whichever is greater.

Variable interest rate penalty to break $300,000 remaining on a mortgage 3 years into a 5 year term is approximately $1,762.50.

Fixed interest rate penalty to break $300,000 remaining on a mortgage 3 years into a 5 year term is approximately $14,375.

If you went with a fixed rate mortgage and broke it early because, for example, you needed to relocate due to work or an addition in your family occurred and you needed to upgrade, you would be paying $12,612.50 more in penalties than if you went with a variable interest rate.

The best part about the new CMHC qualifying rules are it is easier for someone to obtain variable rates and qualify because the new rules force them to down grade their price range, increase their income, or clear away debt to even qualify in the first place. Always talk to a mortgage broker about what your future plans may include, especially when going into a long term mortgage commitment so you can try and avoid massive penalties such as these.

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