5.2.8 Payment types

From: Financial Consumer Agency of Canada

Fixed payments

With fixed payments, you pay one agreed amount with each payment, regardless of changes in the interest rate. If the interest rate goes down, more of the payment applies to the principal and you pay off the mortgage faster. However, if the interest rate goes up, more of the payment applies to interest, and less to the principal. This extends the length of time it will take to pay off your mortgage. You don't know in advance how much of the principal will be paid off at the end of the term.

Variable payments

With variable payments, your payment changes if the interest rate changes. If the interest rate rises, your payments also rise. It's more difficult to plan your mortgage payments over the term of the agreement, so you need to be sure you can adjust your budget to make higher payments. However, the amortization period stays the same. You can tell in advance how much of the mortgage will be paid off at the end of the term, because you pay whatever amount is needed to add up to the agreed amount.

Example

Marina thinks about whether fixed or variable payments will work best for her.
Marina wants to get a mortgage for $95,000. She arranges for a five-year term at a variable interest rate starting at 4.5 percent. If the rates do not change, she will make monthly payments of $525, and by the end of the term, she will have paid $31,548, including $19,955 in interest and $11,593 on the principal. If she chooses fixed payments, she will still pay $31,548 in total, but more or less of that amount will go to her interest. The amount of principal paid at the end of the term will be more or less than the original calculation. If she chooses variable payments, her total payment and her total interest paid will be more or less than the original calculation. But she will still have paid $11,593 on the principal.
Aspects of a mortgage to consider If no change Fixed payments Variable payments
Mortgage amount $95,000 $95,000 $95,000
Interest rate 4.5% Varies Varies
Payments $525 $525 Varies
Interest paid after five years $19,955 Varies Varies
Principal paid after five years $11,593 Varies $11,593
Total paid after five years $31,548 $31,548 Varies

Convertible, capped and hybrid mortgages

Variable interest rate mortgages may also be convertible. With a convertible mortgage, you can "convert" or change it to a fixed interest rate mortgage during the term. Usually there is no extra charge to do so, but conditions may apply, such as the time when you can make the conversion or the maximum interest rate.

Some variable interest rates can be capped—that is, your lender agrees that the interest rate will not rise above a certain level.

In addition, some lenders offer "hybrid" or combination mortgages—part of the mortgage is financed at a fixed rate and part is financed at a variable rate. This gives you partial protection from rising interest rates, and only partial benefits from falling rates. Hybrid mortgages may be complicated, especially if the two portions have different terms (for example, a two-year term for the variable portion and a three-year term for the fixed portion). They may be difficult to transfer if you negotiate a lower rate with a different lender.

Although these terms can offer more protection against high interest rates, they are usually more costly than a simple variable-rate mortgage. You pay a premium for the increased security.

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