Today the market is full of lenders and private banks offering the best rates on mortgages. But the reality on the ground differs. So if you’re a first-time homebuyer, you have to be extra vigilant to choose the best mortgage.
Beyond assessing your needs and budgets, familiarizing yourself with Canada’s popular types of mortgages is also important. The moment you step into a lender’s office, you’ll need to make choices between things like a fixed/variable rate closed mortgage or fixed/variable rate open mortgage.
Variable closed mortgages can be preferable over others due to low-interest rates. But is it the right mortgage for you? Well, it depends upon several factors and individual choices. Therefore, we’ve discussed every aspect of a Variable closed mortgage in the succeeding paragraph to make things simple.
To know more about closed vs. open mortgages beyond this article, click here.
An open mortgage offers flexibility in prepaying the outstanding amount in a lump sum or increasing mortgage repayments. Borrowers have the freedom to close or transfer the mortgage before the term ends without paying penalties.
However, the interest rates on open mortgages are much higher than on closed mortgages. Furthermore, an open mortgage is available for short durations such as six months or one year.
Main advantage: Payment flexibility
Main disadvantage: Higher rate of interest and cost of borrowing.
On the flip side, you can’t pay a closed mortgage before the end of the term without paying the penalty. Commonly termed as prepayment charges, it is levied on the following occasions:
- Prepaying more than the allowed amount
- Breaking mortgage contract
- Switching the mortgage to another lender before the end of your term
- Paying off the entire outstanding amount before the end of your term
Main advantage: Lower interest rates, lower cost of borrowing.
Main disadvantage: No flexibility, penalty for refinancing, or breaking the mortgage before maturity.
The need to compare an open mortgage vs. a closed mortgage only arises if you plan to end the contract early. In Canada, closed mortgages are preferred because they offer lower interest rates than open mortgages with similar terms. However, the terms of the mortgage are restrictive.
In a fixed-rate mortgage, the interest rate remains unchanged throughout the loan period. Also, the total monthly/weekly payments remain the same. Interest rate and principal vary monthly. Interest rates are higher in the case of fixed-rate mortgages.
Main advantage: Protection from the sudden increase in mortgage rates due to market uncertainties.
Main disadvantage: Higher interest rate than a variable-rate mortgage. Qualifying for a loan becomes difficult when the interest rates are high.
Variable-rate mortgage rates vary according to rates set by specific benchmarks such as the lenders’ prime rate or rates set by the Bank of Canada.
Most times, Variable-rate mortgages have a fixed period for which the initial rate remains the same. Further, the interest rate varies as per pre-arranged frequency.
Main advantage: Cheaper than a fixed-rate mortgage. If interest rates fall, so will the mortgage payment.
Main disadvantage: Uncertainty of increasing interest rate, payments fluctuate often.
As the name suggests, it is a type of closed mortgage with variable-rate. It offers lower interest rates compared to other loans with the same term. But before choosing a variable closed mortgage, you should know a few things.
First, being a variable rate loan, the interest follows your lender’s prime rate, which is heavily dependent on the current market trends. Similarly, if the interest rates fall, your mortgage rates also fall.
Second, despite the variable, it is still a closed mortgage. It means all rules of a closed mortgage are applicable, such as prepayment penalties for prepaying the mortgage amount before the end of the term.
However, the main advantage of choosing a variable-rate closed mortgage is lower prepayment penalties. This is because the prepayment penalty is calculated based on three months’ interest.
On the other hand, fixed closed mortgages can bring penalties equivalent to a higher of three months’ interest or an “interest rate differential”.If you want a fixed rate of interest throughout the whole term, you can choose a fixed-rate closed mortgage.
The answer lies in the risk tolerance factor and prospects of a borrower. A variable closed mortgage is the right choice for you, if:
- You are searching for low mortgage rates. A closed mortgage with variables is a win-win opportunity for a borrower who wants to save on interest rates.
- You plan to terminate the contract by paying off the entire outstanding amount early or selling the property. Prepayment penalties can be lower in this type of mortgage loan.
A variable closed mortgage is not the right choice for you, if:
- You want the flexibility of an open mortgage which is the freedom to pay via lump sum or increase prepayments.
- You want a fixed monthly/weekly repayment amount. It is more beneficial for people who want to protect themselves from market uncertainties and have monthly budget allocations.
- Your income is about to increase.
- You want to sell the property.
Even after stepping into a lenders office, ask some questions to get clear insights:
- What is the interest rate?
- What happens if you fail to make a mortgage payment?
- What are the options to repay the mortgage amount?
- What are the prepayment penalties for breaking the contract?
- Are you offering any prepayment privileges?
- What are the monthly payments?
Overall, closed mortgages with variable rates offer some of the best rates while limiting the prepayment penalties to some extent. However, the major setback remains the uncertainty of increased prime mortgage rates.
When considering selecting a mortgage as a critical part of the home-buying process, it is advisable to compare the rates and lenders carefully. In addition, you have the option to use an online mortgage calculator or prepayment penalty calculator to make informed decisions.
And ultimately, borrowers’ risk appetite, prospects, needs, and budgets remain the determining factor.