There are three different ways people typically borrow money to purchase a home: fixed rate mortgages, variable rate mortgages, and home equity lines of credit. Read on to learn more about each.
Fixed Rate Mortgages
Fixed rate mortgages are mortgages where the interest rate stays the same over the entire term of the mortgage. If, for example, your mortgage rate is 3.29 percent in a fixed rate mortgage the interest rate and regular payments will stay the same until it’s time for renewal. Fixed rate terms can range from 1 to 10 years in length.
Fixed rate mortgages are good for many first-time homebuyers. It makes it easier to budget and the payments never fluctuate.
Fixed rate mortgages are like insurance in that you are buying protection and peace of mind from rate increases for the chosen term. You typically pay a higher rate the longer the term length.
Fixed rates can be significantly different between lenders so it’s important to have a mortgage broker on your side.
Fixed rate pre-payment penalties are the greater of three months interest or an Interest Rate Differential. It’s possible for the IRD penalty to be extremely expensive.
Variable Rate Mortgages
Variable rate mortgages get their name because the interest rate changes as the bank’s prime rate changes. The prime rate is a bank’s rate for its best customers and is based on the Bank of Canada’s key lending rate. The rate can change often or it can remain the same for many months.
Typically, people who select variable rate mortgages save more money on their mortgage over time because they aren’t paying the rate premium built into fixed rate mortgages.
If a variable rate mortgage is set up to have constant payments, more or less money will go towards the principal loan amount as interest rates rise and fall. Alternatively, payments can change each time interest rates change.
In the past homeowners could get prime minus 1 percent and prime minus .75 percent, however pricing has increased in the past year and now there is little advantage in taking a variable rate over a fixed rate given the risk of rate increases in the future.
The pre-payment penalties for variable rates is three months interest on a variable rate mortgage making it potentially much more affordable to break an existing mortgage contract.
Home Equity Line of Credit
A home equity line of credit (HELOCs) is a secured line of credit that allows homeowners to access equity in their home at anytime up to a set limit.
These can be powerful, but potentially dangerous financial tools.
HELOCSs are variable rate products and the payments can be as low as interest-only which makes accessing equity for investment purposes very affordable.
One danger is that it’s possible to go years without ever paying down the balance.
New mortgage rules have limited the maximum loan-to-value for HELOCs to 65 percent of the property value.