Fixed or variable? It is the question every mortgage borrower asks, and there is no shortage of opinions. Your bank will probably push you toward a fixed rate because it is easier to sell certainty. The financial media will tell you variable rates save money over time. Neither perspective tells the full story.
The right answer depends on your financial situation, risk tolerance, and how long you plan to keep the mortgage. Here is an honest breakdown of both options so you can make an informed decision.
How Fixed Rates Work
A fixed-rate mortgage locks in your interest rate for the entire term (typically 1 to 5 years, though some lenders offer 7 or 10-year terms). Your payment stays exactly the same from the first month to the last, regardless of what happens with interest rates in the broader economy.
How your fixed rate is determined:
Fixed mortgage rates in Canada are primarily influenced by Government of Canada bond yields, specifically the 5-year bond yield for a 5-year fixed mortgage. When bond yields rise, fixed rates tend to rise. When bond yields fall, fixed rates follow — though lenders do not always pass along the full benefit to borrowers.
Your specific fixed rate depends on:
- Your credit score
- Your down payment size
- Whether the mortgage is insured or uninsured
- The lender you choose
- Your term length
The Semi-Annual Compounding Rule
In Canada, fixed-rate mortgages are compounded semi-annually by law. This means interest is calculated twice per year, not monthly. This is actually an advantage for fixed-rate borrowers compared to variable-rate borrowers, whose mortgages compound monthly. Semi-annual compounding results in slightly less total interest paid over the life of the mortgage.
How Variable Rates Work
A variable-rate mortgage has an interest rate that fluctuates with the lender's prime rate, which is influenced by the Bank of Canada's overnight rate. Your rate is expressed as prime minus (or plus) a discount. For example, prime minus 0.90% means your rate is always 0.90% below whatever the current prime rate is.
Two types of variable-rate mortgages:
Adjustable Rate (Floating Payment)
Your payment amount changes whenever the prime rate changes. If the Bank of Canada raises rates, your payment goes up. If they cut rates, your payment goes down. The proportion going to principal vs. interest stays consistent.
Static Payment Variable
Your payment amount stays the same, but the proportion going to principal vs. interest changes. When rates rise, more of your payment goes to interest and less to principal. When rates fall, more goes to principal and less to interest.
The risk with static payment variable mortgages: If rates rise significantly, you can hit a point where your entire payment goes to interest and none to principal. In extreme cases, you can even reach the trigger point, where your lender forces a payment increase because your mortgage balance has actually grown instead of shrinking.
Historical Performance: Variable Usually Wins
Over the past several decades, studies have consistently shown that variable-rate borrowers pay less interest than fixed-rate borrowers roughly 75% to 80% of the time. This is because fixed rates include a premium for the certainty they provide — you are essentially paying an insurance fee against rate increases.
However, past performance does not guarantee future results, and the 2022-2023 rate hiking cycle was a painful reminder. Borrowers who chose variable rates in 2020 or 2021 at historically low rates saw their rates more than double within 18 months, turning what felt like a smart decision into a stressful one.
The Real Difference: Penalties
This is the factor most borrowers overlook, and it can be the most financially significant aspect of the fixed vs. variable decision.
Variable Rate Penalties
If you break a variable-rate mortgage before the end of your term, the penalty is almost always three months of interest. On a $400,000 balance at 5%, that is approximately $5,000. It is predictable, reasonable, and rarely a dealbreaker.
Fixed Rate Penalties
Breaking a fixed-rate mortgage triggers the greater of three months' interest or the Interest Rate Differential (IRD). The IRD can be enormously expensive, especially if rates have dropped since you locked in.
How the IRD works:
The IRD is the difference between your contracted rate and the lender's current rate for the remaining term, applied to your outstanding balance. If you locked in at 5.5% and the current rate for a similar term is 3.5%, the IRD on a $400,000 balance with 3 years remaining could be $24,000 or more.
The posted rate trap:
Some banks calculate the IRD using their posted rates (which are artificially inflated) rather than their actual discounted rates. This makes the penalty even larger. Monoline lenders typically use more borrower-friendly IRD calculations. This is a critical detail that can save you thousands of dollars.
Why Penalties Matter
Life happens. People sell their homes, get divorced, refinance to consolidate debt, or take advantage of better rates. Statistics show that most Canadian mortgages are broken before the end of the term. If there is any chance you will need to break your mortgage within the next five years, the penalty structure should be a primary factor in your fixed vs. variable decision.
When Fixed Makes Sense
Choose a fixed rate if:
- Payment certainty is essential to your budget — you have little room for fluctuation in your monthly expenses
- You plan to hold the mortgage for the full term — no plans to move, refinance, or make major financial changes
- You are risk-averse by nature — the stress of watching rates fluctuate would affect your quality of life
- Rates are historically low — locking in protects you from future increases (though timing the market is notoriously difficult)
- You are stretching to your maximum qualification — if a rate increase of 0.5% to 1.0% would make your payments unmanageable, a fixed rate provides important protection
When Variable Makes Sense
Choose a variable rate if:
- You have financial flexibility — you can comfortably absorb a payment increase of $200 to $400/month without stress
- You might sell, refinance, or break the mortgage within your term — the lower penalty structure is a significant advantage
- You want to benefit from potential rate decreases — if the Bank of Canada is in a rate-cutting cycle or expected to cut rates
- You are comfortable with moderate risk — you understand rates can go up and you have a plan for that scenario
- You want to accelerate your payoff — start with lower variable payments and direct the savings toward prepayments
The Hybrid Approach
Some borrowers split their mortgage between fixed and variable. For example, putting 60% in a fixed-rate portion and 40% in a variable-rate portion. This gives you partial protection against rate increases while still benefiting from potential decreases on the variable portion.
The downside is added complexity. You have two rates, two portions, and breaking the mortgage becomes more complicated. For most borrowers, committing to one strategy and managing it actively is simpler and more effective.
Current Rate Environment Considerations
As of early 2025, the Bank of Canada has been in a rate-cutting cycle after the aggressive hikes of 2022-2023. Variable rates have become increasingly attractive as the gap between fixed and variable rates has narrowed and the expectation of further cuts remains.
However, rate predictions are exactly that — predictions. No one consistently forecasts interest rates accurately. The Bank of Canada responds to inflation, employment, and global economic conditions, all of which can shift quickly.
What this means practically:
- If you believe rates will continue to fall, variable offers immediate benefit as rates decrease
- If you believe rates have bottomed out or will rise, locking in a fixed rate protects you
- If you are uncertain (which is the honest answer for most people), your decision should be based on your personal financial flexibility, not rate predictions
Making Your Decision
Here is the framework I use with clients:
- Can you afford a payment increase of 2%? If yes, variable is on the table. If no, lean toward fixed.
- Will you likely break this mortgage within 5 years? If yes, variable's lower penalties are a significant advantage.
- What keeps you up at night? If it is rising payments, go fixed. If it is overpaying for certainty, go variable.
- What is the current spread between fixed and variable? If variable is significantly lower (0.5%+), the savings may justify the risk. If they are close together, fixed's certainty becomes more attractive.
There is no universally right answer. There is only the right answer for your specific financial situation, risk tolerance, and life plans. A mortgage broker can model both scenarios with your actual numbers and show you exactly what the best and worst cases look like for each option.
Choose with data, not emotion. And whatever you choose, revisit the decision at every renewal.
