Understanding Variable Rates: How They Work and Who They're Best For

After taking a closer look at the fixed rate in our last article, let's now turn to its great rival: the variable rate. Often seen as riskier, it nonetheless appeals to many borrowers for good reasons. Let's look together at how it works and who it suits best.

How a variable rate works

Unlike the fixed rate, which stays unchanged, the variable rate moves along with financial institutions' prime rate, which is itself directly influenced by the Bank of Canada's decisions. When the central bank adjusts its key rate, your variable mortgage rate generally follows the same movement, whether up or down.

In some cases, your monthly payments stay the same even as the rate changes, but the portion allocated to principal versus interest shifts behind the scenes. In other cases, the actual amount of your monthly payment adjusts directly based on the rate. It's therefore important to fully understand which structure your lender is offering before signing.

What makes the variable rate appealing

The first thing that draws borrowers to the variable rate is that it generally starts from a more favourable point than the fixed rate at signing. For certain buyer profiles, this initial difference can represent real savings, especially if the economic climate remains stable or if rates tend to decrease afterward.

The variable rate also offers an interesting form of flexibility. Many variable-rate products come with lower prepayment penalties than their fixed-rate equivalents, which can be a significant advantage if you plan to sell your property or refinance your loan before the end of the term.

The risks not to underestimate

The flip side of this flexibility is uncertainty. If the economy takes an inflationary turn and the Bank of Canada needs to tighten its monetary policy, your rate can rise, and with it, potentially your monthly payments or the time needed to pay down your principal.

This uncertainty calls for a good amount of financial discipline. You need to be able to absorb variations in your budget without jeopardizing your overall financial stability. A financial cushion or precautionary savings becomes a valuable ally for anyone choosing this path.

Who the variable rate is best suited for

The variable rate works well for people with a higher risk tolerance who are comfortable with the idea of seeing their payments fluctuate based on economic conditions. It often attracts buyers with a solid financial cushion, stable income, and enough savings to absorb potential increases.

This type of rate also appeals to those who closely follow economic news and want to benefit from a potential rate decrease in the coming months or years. Finally, people who plan to sell their property or renegotiate their loan in the medium term may find value in the flexibility this type of product generally offers.

My advice as a broker

Choosing a variable rate should never be based solely on a lower starting point. You really need to take the time to assess your ability to manage uncertainty and absorb changes in your monthly budget. Discuss your options with a mortgage broker who can analyze your full profile and help you determine whether this path truly fits your situation.

Now that we've explored both options separately, our next article will help you compare them directly and determine which one best matches your profile. See you very soon!