The best five-year variable mortgage rates in Canada

Compared to other mortgage products in Canada, five-year variable-rate mortgages are very attractive when market interest rates are low, as they have been for the last several years. Though historically less popular with Canadians than five-year fixed-rate mortgages, variable-rate mortgages offer the possibility of cost savings for home buyers who can tolerate a degree of fluctuation in market interest rates over their five-year terms. But, like all mortgage products, they do have their drawbacks.

Here’s how five-year variable mortgage rates work and how to know if they are the right fit for your finances. And before signing a mortgage contract, learn more about how they compare to five-year fixed mortgage rates.

What is a five-year variable mortgage rate? 

As the name implies, a five-year variable-rate mortgage comes with a mortgage term of five years—that’s the duration for which your mortgage contract remains in effect. In Canada, mortgage terms range from six months to 10 years, with five years being the most popular choice. (Read this to learn about the process of buying a home in Canada.)

With a variable mortgage rate, your interest rate will fluctuate throughout your term, based on changes to your lender’s prime rate. This is in contrast to five-year fixed-rate mortgages, for which the rate does not change. For example, with a variable rate, your mortgage rate may be described as “prime plus” or “prime minus” followed by a percentage. If the lender’s prime rate is 2.5% and your mortgage agreement is for “prime plus 0.5%,” you will pay an interest rate of 3%. However, if the prime rate were to increase to 3%, your interest rate would correspondingly rise to 3.5%. The impact this has on your mortgage payments depends on the type of variable-rate mortgage that you have. 

With some variable-rate mortgages, an interest-rate change does not affect the amount of your regular mortgage payments. Rather, it determines how much of each payment is put towards the mortgage principal and how much goes to the lender in the form of interest. If your variable rate decreases, more of your payment is put towards your principal. If your variable rate increases, a larger percentage is applied to the interest. Though the amount you pay every month does not change, your mortgage amortization is extended when rates rise, which means you’ll end up paying more in interest over time.

Other variable-rate mortgages come with adjustable payments (these are sometimes called adjustable-rate mortgages). With this kind of variable-rate mortgage, your monthly payments change based on adjustments to your interest rate. The amount you pay is based on the relationship between your lender’s prime rate and the rate you agreed to—the prime rate plus or minus a percentage, as stated in your mortgage contract.

How are five-year variable mortgage rates determined in Canada? 

Five-year variable mortgage rates are driven by changes in a lender’s prime rate, which are tied to the Bank of Canada’s overnight rate (a.k.a. the benchmark or overnight rate). 

The Bank changes its benchmark rate according to market conditions. It’s common, for example, for the Bank to raise its benchmark rate when it wants to slow inflation, because when interest rates are high, people tend to spend less. When the Bank raises its benchmark rate, it becomes more expensive for banks to borrow money, and they pass that expense on to customers by increasing their prime rate. When lenders increase their prime rate, variable mortgage rates also rise. And when their prime rate falls, their variable mortgage rates decrease as well. 

Historically, with a few exceptions, variable rates have been lower on average than fixed rates, saving variable-rate mortgage holders money over the long term. However, there are clear signs that the Bank of Canada plans to increase its overnight rate to keep inflation in check and slow the economy. When this happens, banks will raise their prime rates, and thus the cost of a variable-rate mortgage will increase. 

Kristi Hyson, a mortgage associate with Axiom Mortgage Solutions in Calgary, feels that Canadians should get used to rising rates, at least for now. “These historically low rates we’ve been seeing are not going to stick around,” she says. “Now that the economy is starting to pick up, rates are going to become more normalized. If you’re just entering the housing market now and are expecting to have the low rates we’ve been seeing for the last two years, you’re going to be disappointed.” 

The pros and cons of five-year variable-rate mortgages

Pros to consider: 

• Potential cost savings: History shows that variable rates tend to be lower than fixed rates over the long term, which could save you money. 
• Fewer prepayment penalties: Variable-rate mortgages are typically more flexible than fixed-rate mortgages, allowing you to make extra payments towards your mortgage without paying a fee.
• The ability to convert your mortgage: Many lenders allow you to convert your variable-rate mortgage to a fixed-rate mortgage without paying a penalty. 

Cons to consider: 

• Less predictability: Unlike with fixed-rate mortgages, you can’t be sure what your interest rate will be for the duration of the term. This can make budgeting more difficult or cause stress for borrowers who may have difficulty making higher mortgage payments than they were at the beginning of their contract. 
• Potential to pay more: Whether or not your mortgage payments increase when your lender’s prime rate rises, that rate increase will cost you more in interest over the long term. 

Is a variable-rate mortgage better? 

While it’s important to consider the pros and cons of a mortgage product, whether or not a five-year variable-rate mortgage is the right choice comes down to what a home owner is financially and emotionally comfortable with, says Hyson. For a family on a very tight budget who can’t handle an unexpected increase in rates, a variable-rate mortgage may not be the right product. If, however, the home owners have a lot of disposable income and can afford to pay more when the prime rate increases, then a variable-rate mortgage may be a good fit.

Variable-rate mortgages “can save you a lot of money throughout the duration of your term,” says Hyson. “That being said, a variable-rate mortgage is not for the weak of heart. It’s no different than people looking at investments. If you’re [comfortable with] high risk, you can deal with fluctuations and ride them out. If not, you’re going to lose sleep over every rate change, in which case a variable rate is probably not right for you. There’s no need to be in a mortgage, whether it be fixed or variable, that’s going to cause you undue anxiety.”

Choosing a closed versus open variable-rate mortgage

Variable-rate mortgages can be open or closed. The main differences between closed and open variable-rate mortgages are cost and flexibility. With an open mortgage, you can make additional mortgage payments without the fear of a prepayment penalty, but you pay for this flexibility with a higher interest rate. In contrast, closed mortgages often have a lower interest rate, but in exchange for the more favourable rate, your prepayment options will be more limited. 

If you plan to stay in your home for at least five years and don’t expect a financial windfall or huge income increase in the foreseeable future, a closed mortgage with a variable rate may be a good option. If you’re not likely to come into lots of money (and hence won’t want to make any big prepayments), it’s worth taking advantage of the savings you’d get with a closed variable-rate mortgage.

Should you choose a five-year variable mortgage rate? 

When deciding if a variable mortgage rate is right for you, there are a number of key factors to consider, including the potential cost and savings, and the risk of a change in interest rates. Although rates are likely to increase in the coming months and years as the Bank of Canada works to stabilize the economy, variable rates remain attractive for many buyers. The decision ultimately comes down to your ability and desire to manage the possibility of changes in the economy and market interest rates.