5-Year Variable Mortgage Rates

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5-Year Variable Mortgage in Canada: Full Guide

This Page's Content Was Last Updated: August 18th, 2022

The 5-year variable mortgage is Canada's most popular variable-rate mortgage. It is called a variable-rate mortgage because the rate is based on a lender's Prime rate, and can go up or down throughout the 5 years of the mortgage. While the 5-year variable rate and the 5-year fixed rate are usually similar, homeowners with variable rate mortgages in 2020 have seen a dramatic drop in their mortgage rates due to the Bank of Canada lowering their interest rate due to COVID-19.

1. Mortgage rate is based on a lender's Prime rate for a 5-year term
2. Generally has the best mortgage rate compared to other variable mortgage terms
3. Offered by almost all lenders

A variable-rate mortgage is a mortgage where the interest rate is based on the Prime Rate. This means that the interest rate can go up or down throughout the mortgage term, depending on how the Prime Rate changes. A common misconception with variable rate mortgages is that your monthly mortgage payments will vary with the interest rate, which isn't true. Although in very rare cases, such as with the Scotiabank Flex Mortgage, your payments will change with rates.

While your payments stay the same, the amount of interest you pay changes. Each mortgage payment contributes to the mortgage principal and interest. An increased mortgage rate means a higher percentage of each payment is spent on interest. With less of each payment contributing to the principal, you'll be paying off your mortgage balance slower. As a result, you'll need to increase your mortgage payments to make up for having less of your mortgage balance paid off in the next term.

The opposite is true if the variable rate decreases throughout your term. A decreasing variable rate means you'll pay less interest, and more of each payment contributes to your mortgage principal. You will be paying off your mortgage faster with each payment. Your mortgage payments will likely decrease in the next term because you'll be ahead of your mortgage payment schedule.

Overall, it's essential to understand that changing variable rates won't affect your monthly mortgage payments. Instead, the rates will determine what percentage of each mortgage payment contributes to the principal and interest. An increasing variable rate means less of your payment goes to the principal, and you'll be paying off the mortgage slower. As a result, you'll need to increase your mortgage payments next term because you'll be behind your mortgage payment schedule.

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Just like how the 5-year fixed rate mortgage is the most popular mortgage in Canada, the 5-year variable rate is one of the most popular mortgages in Canada. The main reason for this is the possibility of large savings that variable rates provide. Variable mortgage rates are often priced well below fixed rates, making them an enticing choice for homeowners looking for the absolute lowest mortgage rate. The ability to save money when interest rates fall makes variable rate mortgages powerful, however, it can be a double-edged sword that costs borrowers more money should rates increase instead.

In light of a trend of decreasing interest rates in Canada in recent history, variable rates have outperformed fixed rates in terms of mortgage interest savings, and allows homeowners to speculate on future interest rates. If market interest rates decrease or stay flat during your term, then variable rates come out ahead.

There is also restricted availability of variable mortgage terms. Many variable rate lenders offer 5-year terms, but only a few offer variable rate terms that are less than 5 years. For example, RBC and TD only offer variable rate mortgages with a 5-year term. Other lenders, such as Scotiabank, CIBC, and BMO, only offer variable rate mortgages with a 5 year or 3 year term.

For many homeowners, a 5 year term can be a more attractive option compared to a 3 year term. Having a longer term means that they won’t have to go through the mortgage renewal process as often. There’s also many lenders offering 5-year variable rate mortgages, which is why 5-year variable rates are so low compared to 3-year variable rates. In some cases, 5-year variable rates can be half of 3-year variable rates.

While 5-year terms might have a lower variable rate, a 5-year term might not always be the best option for some homeowners. For closed variable mortgages, breaking your mortgage, such as by refinancing or selling your home, might cause you to have to pay significant mortgage penalties. If you think that you'll need to break your mortgage soon, then a 3-year variable rate mortgage can be a better option than a 5-year mortgage.

Having a variable mortgage with a longer term length also means that you'll be subject to variable rates for a longer period of time. For those that can't handle a higher level of risk, a longer-term might not be a great option.

It's important to understand that a variable rate mortgage is constantly changing. This means that the interest rate you receive at the beginning of your term might not be the same as at the end of your term.

While a variable rate mortgage is constantly changing, you have the option to "lock in" your rate at any time during the term of your mortgage. This means that you'll be guaranteed the same interest rate for the remainder of your term, even if the Prime Rate changes.

Keep in mind that you will likely have to pay a fee to lock in your rate. This fee is usually a percentage of the mortgage amount and can be from 0.5% to 2%.

Locking in your mortgage rate can provide some security, especially if you think interest rates will rise. However, if interest rates go down during your term, you might have missed out on a lower interest rate.

You may have heard of an open vs. closed mortgage before. The difference is your ability to pre-pay your mortgage without penalties. An open mortgage allows you to pre-pay an unlimited amount of mortgage principal every year. However, you'll have a higher mortgage interest rate than a closed mortgage in exchange for this benefit.

A closed mortgage still allows you to make annual mortgage prepayments but are capped at a certain percentage of the principal. Most Canadian mortgage lenders enable you to pre-pay 10% to 20% of the mortgage principal every year without penalties. If you decide to pre-pay more than you're allowed, you must pay mortgage prepayment penalties.

Overall, an open mortgage is better if you expect to make significant mortgage prepayments during your term. Otherwise, it's best to stick with a closed mortgage and have a lower interest rate.

Since peaking in 1981, with a mortgage interest rate of 19.81%, the 5-year variable mortgage rate has decreased over the past four decades. The record-high interest rates were due to the two oil crises of the 1970s.

In 1973 and 1979, Canada experienced a rapid increase in oil prices. In response to this inflation, The Bank of Canada raised the Prime Rate, which increased variable mortgage rates.

Next, another significant change to the 5-year variable rate was in 2009 when the Bank of Canada lowered the Prime Rate to stimulate the economy. This led to a decrease in the 5-year variable mortgage rate to 1.95%.

Following economic recovery from the Great 2008 Recession, The Bank of Canada began to raise the Prime Rate. However, in 2020, Covid-19 devastated the global economy. The bank had no choice but to stimulate economic growth by slashing interest rates. As of 2022, the 5-year variable rate sits around 2.15%. However, economists expect it to increase throughout the coming years.

Your variable mortgage rate is directly influenced by The Bank of Canada rate. As a result, it's essential to understand why The Bank of Canada changes rates. In general, The Bank of Canada rate is a tool used to balance economic growth with inflation.

Lower interest rates allow homebuyers, consumers, and businesses to borrow more money to spend and invest cheaply. As a result, lower interest rates stimulate the economy because:

• More people buy homes
• Businesses invest in growth and hire more employees
• Consumers do more shopping

However, after prolonged periods of low interest rates, everything becomes more expensive. This is known as inflation, which increases the everyday cost of living. For example;

• Home prices increase due to higher demand
• Businesses increase the cost of their products
• Economic growth increases demand for oil, and gasoline prices

To cool down inflation, The Bank of Canada must increase interest rates to make the cost of borrowing more expensive. This increased rate will directly apply to your mortgage, and you'll pay more interest throughout your variable rate mortgage term. Given the high cost of living increases in Canada, it's expected that The Bank of Canada will increase the interest rates. To summarize, interest rates are changed to influence economic growth and cool down inflation.

Source: Statistics Canada

Source: Statistics Canada

A capped variable rate is a maximum limit that your variable mortgage rate can go to during your term. This limit protects you from significant interest rate increases, but your base variable rate may be higher to account for this feature.

You might want to benefit from any decrease in interest rates, but you want to limit how high your mortgage interest rate can go. For example, a mortgage lender might offer a variable rate of 2.00%. For a variable rate mortgage with a capped rate, the mortgage rate might be slightly higher, such as at 2.50%. Some lenders might have a capped rate that can already be extremely high, such as 7%. Should variable mortgage rates rise to 10%, your variable mortgage rate will be capped at 7%.

Historically, borrowers with variable mortgages have saved money compared to borrowers with fixed mortgages. If you’re willing to put up with a little more uncertainty and to take on more risk, then a variable mortgage gives you the possibility of saving money. For borrowers not willing to take the gamble of getting a variable rate, then a fixed rate allows borrowers to pay a slight premium for peace of mind, knowing that their mortgage rate can’t increase in the meantime. Depending on your variable mortgage, interest rate changes can have a significant impact on your finances if your payment fluctuates with your rate, or no immediate impact at all on your budget if it is fixed. It’s possible to hit your mortgage trigger rate with a variable mortgage, which is when your monthly payments aren’t enough to cover interest. That might happen if rates significantly increase during your variable mortgage term.

A mortgage’s annual percentage rate (APR) adds in any additional costs of your mortgage and then turns it into an annual rate. This allows you to consider any other fees that you have to pay besides just your mortgage interest. If there is no other cost, then a variable mortgage rate would be the same as the APR.

For example, TD shows a variable mortgage rate’s APR along with the posted variable mortgage rate. In their APR calculation, they consider a $300 home appraisal fee for a mortgage with a 25-year amortization. For a $300,000 mortgage with a 5-year term, this adds 0.02% on top of your variable mortgage rate. For TD's posted 5-year variable mortgage rate of 1.55%, the APR is 1.57%.

Comparing variable mortgage rates is a great way to see which lenders are offering competitive variable rates. You can then negotiate with your lender or use a mortgage broker to try to get a lower variable rate. It’s important to remember that you might not be able to get a low posted variable rate that you saw online, which may only be available for specific conditions, such as for insured high-ratio mortgages. A bank’s prime rate is also for a bank’s prime customers. If your financial situation isn’t great, such as if you have bad credit, then you may find that variable mortgage rates offered to you might be higher.

The absolute lowest variable mortgage rate might not always be the best option either. If you need specific features, such as prepayment privileges or mortgage portability, then you need to make sure that your mortgage lender has such options. Otherwise, a low variable mortgage rate might be cancelled out through mortgage penalties.