Knowing what is a fixed rate mortgage is essential if you plan on buying a home as it’ll impact how much you’re paying each month.

One of the biggest debates in the finance world is what type of mortgage you should get, especially when it comes to choosing between a fixed mortgage rate or a variable mortgage rate. Both have their pros and cons, and at the end of the day, it is an individual decision that depends on your individual situation. But to help you make that decision here’s what you need to know about a fixed rate mortgage. 

What is a fixed rate mortgage?

A fixed rate mortgage is when the interest rate stays the same for the duration of the life of the loan, known as the term. A fixed interest rate mortgage stays constant despite any rate changes in the market. This means that if interest rates go up, you are protected. However, it also means that if interest rates go down, you are locked in. 

Fixed mortgage rates are ideal for borrowers who want to know exactly how much they are paying every month. Keep in mind, due to the fact that fixed-rate loans are deemed a less risky option, they are often less flexible and have higher interest rates than variable mortgages. As in, you’ll typically pay a higher prepayment penalty compared to variable rate mortgages. 

How are interest rates determined

Whereas the Bank of Canada’s overnight rate determines variable interest rates, it’s actually the bond market that helps determine the interest rates for fixed interest. The bond market is significantly bigger than the stock market, and banks turn to bond yields to anchor their fixed rates. That being said, mortgages are considered to be ‘high maintenance’ income for banks and other lenders, so while they use the bond yield as a baseline, they will set higher fixed rates. While fixed rate mortgages do follow bond yield trends in going up or down, banks are faster to increase fixed rates and slower to lower them.

Financial institution rates

The posted rate you will see listed by a lender isn’t always necessarily the rate you will end up paying. Big banks especially tend to lead with a posted rate, but when you go in and speak to them individually, they can often negotiate a lower rate. This is known as the “discount rate,” and it’s available to just about everyone.

While this may seem like a good deal, you do need to read and understand the small print of what is included in that deal. The loan terms for that rate may not benefit you in the long run. 

It’s also worth noting that the ‘discount rate’ is a common tactic used by Canada’s big banks and while it might seem like you are getting a discount, there might still be better rates out there with other mortgage lenders. It’s worth your time to shop around before deciding. 

In addition, the length of your home loan will have an impact on your mortgage. For example, home buyers that take a fixed mortgage with a 3-year term will typically get a lower rate than a 5-year term.

Your individual situation

Bond yields and financial institutions both play a big role in determining fixed interest rates but potential homeowners also need to remember that their individual situation and financial history plays a big role in interest rates as well. 

Individuals who have a solid credit history and minimal debt are much more likely to get approved and be offered a lower interest rate than individuals who have a poor credit score and/or are struggling with debt. These individuals are seen as a higher risk of defaulting on their payments and, as such, the bank or lender will offer a higher interest rate as an added security.

Another factor to consider is insurance premiums like mortgage insurance. Mortgage insurance is required for anyone whose down payment is less than 20% of the purchase price of the home. 

Having a larger down payment will decrease your loan amount, but bank also sees individuals who require mortgage insurance to be safer than those who don’t. As such, homebuyers who need mortgage insurance are also likely to get a lower fixed rate mortgage than homebuyers who don’t need mortgage insurance. 

Open vs. closed fixed rate mortgage

Fixed rate mortgages are known to be less flexible than variable rate mortgages, but you can increase the flexibility by choosing an open mortgage rather than a closed mortgage. 

So, what’s the difference?

An open mortgage allows more prepayment options without penalties. Basically, you can increase your monthly mortgage payment or make lump-sum payments as you please. Open mortgages also tend to be easier to refinance. However, open mortgage interest rates are higher rates than closed mortgage interest rates, because lenders won’t make as much money.

Closed mortgages may offer a little bit of wiggle room in terms of prepayments but they do have caps. Anything past this pre-determined maximum amount results in the homebuyer being penalized. For example, you might be allowed to add 15% to your monthly payments and pay an additional 15% of the total amount of your loan each year without paying a fee.

Pros and cons of a fixed rate mortgage

Fixed rate mortgages are known for their stability and safety but before you decide on whether or not they are the best option for you, here’s a quick list of some pros and cons to be aware of. 

Fixed rate mortgage pros

• Offers stability
• Set it and forget it monthly payments 
• Great for budgeting

Fixed rate mortgage cons

• Higher interest rates
• Historically, does not perform as well long-term as variable rates
• More expensive to break than variable rate mortgages

Fixed vs. variable rate mortgages

So, is a fixed rate mortgage loan better than a variable rate mortgage or adjustable-rate mortgage? Neither is necessarily better than the other, it depends on your needs and circumstances. 

Variable rate mortgages are seen as riskier because even though your mortgage payments stay the same, the interest rate can change. If rates go down, then that’s more money towards your principal which means more home equity. However, rates can just as easily go up which means higher interest payments and less towards the actual loan. Historically, variable rate mortgages do perform better long-term, but they aren’t for everyone.

Fixed rate mortgages are seen as the safe option since they offer a reliable and constant payment schedule and while this might mean higher interest rates, it’s a lot easier and less stressful for individuals who are money-conscious and prioritize budgeting. Plus, while variable rates might be best long-term, not everyone has long-term goals with their properties.

At the end of the day, the best option is the one that works best for your circumstances. You can learn more to compare the two options here.

How to get the best fixed rate mortgages

When looking for a fixed-rate mortgage you’ll want to spend the time to shop around to ensure you get the lowest rates possible. If you find this overwhelming or just don’t have the time, consider working with a mortgage broker who will do the leg work for you.

Keep in mind that your individual circumstances also play a large role in determining your offered interest rate. So, ensure that you are in the best financial standing possible before you start to apply.

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