What are the differences between fixed and variable-rate mortgages?

by | May 2, 2024 | Finance and Business

For many people, buying a home is the single biggest purchase they will ever make.

While the excitement of finding your dream home can be exhilarating, those feelings can sometimes give way to stress and confusion when it comes time to apply for a mortgage.

Whether you’re a first-time homebuyer or are looking for a new place to call home, it’s important to understand the terms of a mortgage agreement and how the mortgage process works.

To help you get started, here’s a breakdown of some of the key terms you should know.

What are the differences between fixed and variable interest rates?

A key step towards homeownership is deciding what type of interest rate works best for you and your family.

You’ll need to decide between a fixed-rate or a variable-rate mortgage. As part of this process, you may want to speak to your lender to help you decide which option works for your specific needs and how comfortable you are with the possibility that your interest rate could change during the term of your mortgage.

Fixed rate
For fixed-interest-rate mortgages the rate will not change over the course of a term, regardless of prime rate fluctuations. As your interest rate is locked in, fixed-rate mortgages offer the security of knowing your payments will not change over the term of your mortgage. However, you may see the impact of changes to rates when you renew.

Variable rate
The interest on a variable-interest-rate mortgage can fluctuate with changes to the lender’s prime rate. However, the amount of each payment generally stays the same.

If the prime rate rises, then typically more of each payment will go towards paying the interest, and a smaller portion will go towards paying the outstanding balance. This means your payments may increase if you change your payment schedule during the term or at the time of renewal to get you back to your original repayment schedule (i.e., your amortization period).

While you’re not required to make changes when your interest rate increases, you do have options, which may include making a lump-sum payment, increasing your payment amount or converting to a fixed-rate mortgage. Connecting with a mortgage specialist may help you to figure out what may work best for your unique needs.

When interest rates increase and the payment doesn’t change, the payment amount may no longer cover the interest charged on a variable-interest-rate mortgage. This means you have passed the trigger rate.

After you pass the trigger rate on a variable interest rate mortgage, unpaid interest will start to increase the amount owing. At a certain point, you may reach what’s called the trigger point, and you will then be required to adjust your payments, make a prepayment or convert to a fixed-rate mortgage.

Learn more about the different types of mortgages and options you have at td.com

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