Choosing between a fixed and variable mortgage rate is one of the biggest decisions Canadian homebuyers make. Both are valid strategies — the right choice depends on your situation, not which one is “better” in the abstract.
The core difference
| Feature | Fixed Rate | Variable Rate |
|---|---|---|
| Rate during term | Locked in — does not change | Moves with Bank of Canada/prime rate |
| Monthly payment | Predictable for full term | May change (ARM) or have varying principal allocation (VRM) |
| Rate benchmark | Government of Canada bond yields | Bank of Canada overnight rate → prime rate |
| Current pricing | Typically higher than variable | Typically lower than fixed (discount to prime) |
| Break penalty | Greater of IRD or 3 months’ interest | Almost always 3 months’ interest only |
| Best for | Certainty-seekers; tight cash flow | Flexibility-seekers; rates expected to fall |
Fixed-rate mortgages in detail
How rates are set
Fixed mortgage rates in Canada are driven primarily by 5-year Government of Canada bond yields (for 5-year fixed) — not the Bank of Canada short-term policy rate. When bond markets move (due to inflation expectations, economic data, or global events), fixed rates adjust accordingly.
This is why fixed rates can rise even when the Bank of Canada hasn’t moved, and vice versa.
Payment certainty
Your monthly payment stays the same throughout the term — principal and interest portions adjust over time according to the amortization schedule, but your total payment does not change. This makes budgeting straightforward.
Example (5-year fixed):
- Mortgage: $500,000 at 5.00% fixed, 25-year amortization
- Monthly payment: ~$2,908
- This number does not change for the full 5 years
The IRD penalty risk (fixed)
Breaking a fixed-rate closed mortgage before the end of the term triggers the Interest Rate Differential (IRD) penalty if it exceeds three months’ interest.
The IRD is designed to compensate the lender for lending your funds out again at a lower rate than your contract rate.
Simplified IRD example:
- Balance: $425,000, contract rate: 5.50%, 3 years remaining
- Lender’s current 3-year posted rate (used in calculation): 3.80%
- Difference: 1.70%
- IRD penalty: $425,000 × 1.70% × 3 = $21,675
Lenders use different comparison rates in their IRD formula (posted rates vs. discounted rates), which can make penalties even higher at big banks. Credit unions and monolines (like First National, MCAP) often calculate more borrower-friendly IRD penalties.
Variable-rate mortgages in detail
How rates are set
Variable rates are quoted as prime ± a spread (e.g., Prime − 0.50%, Prime + 0.25%). The spread is set when you take out the mortgage and stays fixed for the term. Only the Bank of Canada policy rate — and therefore prime — changes.
When the Bank of Canada raises the overnight rate by 0.25%, your variable rate rises by 0.25% within days. When the Bank cuts, your rate falls.
VRM vs. ARM: two variable structures
Variable-Rate Mortgage (VRM) — fixed payment:
- Your regular monthly payment dollar amount stays constant
- When rates rise, more of that payment is allocated to interest, less to principal
- Your mortgage could end up with a longer-than-expected amortization (called hitting the “trigger rate”)
- RBC, TD, BMO traditionally offer this structure
Adjustable-Rate Mortgage (ARM) — adjusting payment:
- Your monthly payment amount adjusts when rates change
- Principal repayment stays roughly on schedule
- More predictable amortization, less predictable monthly cash flow
- HSBC Canada (now RBC), some credit unions, and monoline lenders may offer this
Trigger rate (VRM-specific): If rates rise enough that your fixed payment no longer covers even the full interest owing, you hit the “trigger rate.” Your lender will typically contact you to increase your payment or make a lump-sum payment to bring things on track.
The prepayment penalty advantage
Variable-rate closed mortgages almost always have a prepayment penalty of three months’ interest — a significant practical advantage:
| Mortgage | Balance | Rate | 3 months’ interest |
|---|---|---|---|
| Variable $450K at 4.75% | $450,000 | 4.75% | $5,344 |
| Fixed $450K at 5.25% — if IRD applies | $450,000 | 5.25% | IRD could be $15,000–$30,000 |
If you end up selling, divorcing, or refinancing mid-term, the variable penalty is almost always much smaller.
Historical performance: which has cost less?
Numerous academic studies and mortgage industry analyses in Canada have found that variable-rate borrowers paid less interest over time in most historical periods. The most-cited Canadian study (Moshe Milevsky, York University, “Mortgage Financing: Floating Your Way to Prosperity”) found variable rates were cheaper roughly 85–90% of the time across Canadian mortgage history.
However, this advantage assumes:
- You can absorb rate increases without financial stress
- Rates don’t rise dramatically and stay high for the full term
- You don’t break the mortgage and reset with a variable disadvantage
The 2022–2023 Bank of Canada rate-hike cycle (from 0.25% to 5.00% in 16 months) was one of the fastest in history. Variable-rate holders who took mortgages at Prime − 1.00% (rate of ~1.45%) saw their rate hit 6.45% or higher. Monthly payments on a $600,000 VRM increased by over $1,800/month in some cases.
Rate comparison illustration (2026 hypothetical)
| Product | Example rate | Monthly payment on $500K, 25yr amort |
|---|---|---|
| 5-year fixed closed | 4.89% | $2,846 |
| 3-year fixed closed | 4.74% | $2,809 |
| 1-year fixed closed | 5.10% | $2,894 |
| Variable closed (Prime − 0.50%) | 4.45% | $2,716 |
| Variable open | 6.75% | $3,395 |
At a 0.44% rate difference (5-year fixed vs. variable above), the variable rate saves approximately $130/month initially — but this gap widens or closes with every Bank of Canada move.
How to decide: fixed or variable?
Lean toward fixed if:
- Your budget is tight and a $300–$500/month payment increase would cause real stress
- You are a first-time buyer already stretching to qualify
- You believe rates will rise or stay elevated
- You have a predictable income and want certainty
- You have no likelihood of breaking the mortgage early
Lean toward variable if:
- You have cash flow cushion to absorb rate increases
- You may need to break the mortgage mid-term (job relocation, sale, divorce)
- You believe rates will stay flat or trend down
- You are financially sophisticated and comfortable monitoring rate decisions
- You want the option to convert to fixed if rates spike unexpectedly
Lean toward shorter fixed (1-year or 3-year) if:
- You think rates will fall but want more certainty than variable
- You want to re-evaluate more frequently than 5 years without a large penalty
- You expect your situation to change significantly
Mortgage term vs. amortization (common confusion)
- Term: The length of your mortgage contract (1–10 years). When it ends, you renew.
- Amortization: The total time to pay off the entire mortgage (most common: 25 years).
You will renew your mortgage approximately 5 times over a 25-year amortization. You choose fixed vs. variable each time you renew — you are not stuck with one choice for the full 25 years.