How Mortgage Rates Work: Fixed vs. Variable

Tim Lyon • September 26, 2025

What affects mortgage rates? Does the Bank of Canada rate affect fixed-rate mortgages? These are questions that come up all the time, so in this this post, I’ll explain how fixed and variable rates are determined, why they don’t always move together, and what that means for you as a borrower.


But to start with the short answer: While Bank of Canada announcements immediately impact variable rates, fixed rates usually have those expectations already baked in long before the announcement. That’s because fixed rates are forward-looking — they reflect where markets think rates are headed, not just where they are today.


What Are Fixed and Variable Rates?

Fixed Rate

The interest rate stays the same for the entire mortgage term. Payments remain consistent, no matter what happens in the market.


Variable Rate

The interest rate changes during the mortgage term, moving up or down depending on the lender’s prime rate. Payments may stay the same (VRM) or change (ARM).


How Do Fixed Rates Work?

When you choose a fixed rate, the lender is guaranteeing your rate for the length of your term. To do this, they need to estimate what a fair rate will be over that time. This makes fixed rates more forward-looking — they often reflect not just today’s conditions, but also what the market expects to happen in the future.


Key Points About Fixed Rates
  • Strongly influenced by the Canadian bond market (especially the 5-year government bond yield).
  • Lenders adjust their fixed rates based on investor expectations for inflation and future interest rates.
  • Often, Bank of Canada moves are already baked into fixed rates before they happen.


Example

If bond yields suggest that rates will rise in the next year, lenders may increase fixed rates now, even if the Bank of Canada hasn’t made a move yet.


How Do Variable Rates Work?

Variable rates move directly with the Bank of Canada’s overnight rate. When the Bank of Canada raises or lowers its rate, lenders adjust their prime rate accordingly, and variable mortgages follow.


For borrowers, the most important detail is the discount from prime, because that sets the actual rate you pay. For example, if prime is 4.95% and your mortgage is Prime – 0.5%, your rate is 4.45%.


The discounts lenders offer change over time. In periods of economic uncertainty, lenders usually shrink the discount they offer, which can make new variable mortgages less attractive even if prime is coming down.


Key Points About Variable Rates
  • Directly tied to the Bank of Canada’s overnight rate, which is reviewed eight times a year.
  • Banks adjust their prime rate in response to these moves.
  • Your actual rate = Prime – discount (e.g., Prime – 0.5%).


Example

If prime is 4.95% and your mortgage is Prime – 0.5%, your rate is 4.45%. If the Bank of Canada cuts rates by 0.25%, prime drops to 4.70%, and your rate automatically drops to 4.20%.


Why Don’t Fixed and Variable Always Move Together?

  • Fixed rates reflect the bond market, which looks ahead at where rates and inflation may go.
  • Variable rates respond directly to Bank of Canada decisions, reflecting current conditions.
  • This is why fixed rates can fall while variable rates stay flat, or vice versa.


Next Steps

If you’re deciding between fixed and variable, understanding how each is set is the first step. The next is to match the right mortgage type to your budget and comfort with risk. If you’d like to review which option works best for you, I’d be happy to help.


Need help with your mortgage? Book a consultation or call 778-988-8409.


Mortgage Term Glossary

Amortization: The total length of time it will take to pay off your mortgage completely (typically 25–30 years in Canada).
Bond Yield: The return investors get from government bonds. Used as a benchmark for fixed mortgage rates.
Discount (Variable Rate): The amount subtracted from prime to determine your actual mortgage rate.
Fixed Rate: An interest rate that stays the same for the entire mortgage term.
Mortgage Term: The length of your mortgage contract with your lender (typically 1–5 years), after which you need to renew.
Overnight Rate: The interest rate at which major banks borrow and lend money to each other, set by the Bank of Canada.
Prime Rate: The interest rate banks use as a baseline for loans, influenced by the Bank of Canada’s overnight rate.
Variable Rate: An interest rate that changes during your mortgage term based on lender prime rates.

Tim Lyon

Mortgage Consultant

Fixed vs. Variable Mortgages: Which is Right for You?

By Tim Lyon • September 25, 2025
When arranging a mortgage, one of the first decisions you’ll need to make is whether to go with a fixed or variable rate. Both options have their own benefits and challenges, and understanding the differences will help you choose the one that fits your financial situation best. In this post, we’ll break down the differences between fixed and variable mortgages, how they’re priced, the pros and cons of each, and what you should consider before making a decision. What are Fixed and Variable Mortgages? Fixed Rate Mortgage: Your interest rate stays the same for the entire mortgage term. That means your monthly payments won’t change, making budgeting more predictable. Variable Rate Mortgage: Your interest rate changes during the term. There are two main types: Variable Rate Mortgage (VRM): Your payment amount stays the same, but how much goes toward principal vs. interest changes as rates move. Adjustable Rate Mortgage (ARM): Your payment amount itself changes when rates move. How Do Fixed and Variable Mortgages Work? Fixed Your rate is set when you sign your mortgage contract. Payments remain consistent, regardless of whether interest rates rise or fall. Fixed rates are heavily influenced by the Canadian 5-year bond yield. Variable Your rate is tied to your lender’s prime rate, which follows the Bank of Canada’s overnight lending rate (reviewed 8 times a year). Lenders usually offer a discount from prime, such as Prime – 0.4% . You can often lock into a fixed rate at any time (though usually for a term equal to or longer than what’s left on your mortgage). Penalties for Breaking Your Mortgage Fixed The greater of three months’ interest or the Interest Rate Differential (IRD). IRD can be very costly if rates have dropped since you signed. Variable Always three months’ interest — simpler and usually less expensive. Pros and Cons Fixed Rate Pros: Predictable payments, easier budgeting Protection if rates rise Currently about 1% lower than variable, meaning you may qualify for more Fixed Rate Cons: More penalty risk if you break the mortgage early You miss out if rates fall Variable Rate Pros: Benefit if rates decrease Less penalty risk(3 months’ interest) Option to lock into fixed at any time Variable Rate Cons: Payments (ARM) or interest portion (VRM) can rise if rates go up Less predictable for budgeting Lock-in rates may not always be the best available  Quick Summary • Fixed mortgages = stable, predictable, tied to bond yields, but more penalty risk. • Variable mortgages = tied to Bank of Canada, potential savings, lower penalty risk, but less predictable. • VRM vs. ARM = VRM keeps payments steady while ARM adjusts payments with rates. Next Steps Choosing between fixed and variable depends on your risk tolerance, financial goals, and comfort with rate changes. If you’re unsure which option is right for you, let’s talk about your situation and find the best fit. Need help with your mortgage? Book a consultation or call 778-988-8409 . Mortgage Term Glossary Adjustable Rate Mortgage (ARM): A variable mortgage where payments increase or decrease as rates change. Amortization: The total length of time it will take to pay off your mortgage completely (typically 25–30 years in Canada). Bond Yield: The return investors get from government bonds. Used as a benchmark for fixed mortgage rates. Down Payment: The upfront amount you pay toward the purchase price of a home, expressed as a percentage of the total price. Equity: The difference between what your home is worth and what you owe on your mortgage. Fixed Rate: An interest rate that stays the same for the entire mortgage term. Interest Rate Differential (IRD): A penalty calculation for breaking a fixed mortgage when current rates are lower than your original rate. Lock-In: The option to switch from a variable mortgage to a fixed mortgage during your term. Mortgage Term: The length of your mortgage contract with your lender (typically 1–5 years), after which you need to renew. Prime Rate: The interest rate banks use as a baseline for loans, influenced by the Bank of Canada’s overnight rate. Variable Rate Mortgage (VRM): A variable mortgage where payments stay the same, but the principal vs. interest split changes with rate moves. Variable Rate: An interest rate that changes during your mortgage term based on lender prime rates.

Locking in a Variable Rate Mortgage

By Tim Lyon • September 25, 2025
If you have a variable rate mortgage and recent economic news has you thinking about locking into a fixed rate, here’s what you can expect will happen. You can expect to pay a higher interest rate over the remainder of your term, while you could end up paying a significantly higher mortgage penalty should you need to break your mortgage before the end of your term. Now, each lender has a slightly different way that they handle the process of switching from a variable rate to a fixed rate. Still, it’s safe to say that regardless of which lender you’re with, you’ll end up paying more money in interest and potentially way more money down the line in mortgage penalties should you have to break your mortgage. Interest rates on fixed rate mortgages Fixed rate mortgages come with a higher interest rate than variable rate mortgages. If you’re a variable rate mortgage holder, this is one of the reasons you went variable in the first place; to secure the lower rate. The perception is that fixed rates are somewhat “safe” while variable rates are “uncertain.” And while it’s true that because the variable rate is tied to prime, it can increase (or decrease) within your term, there are controls in place to ensure that rates don’t take a roller coaster ride. The Bank of Canada has eight prescheduled rate announcements per year, where they rarely move more than 0.25% per announcement, making it impossible for your variable rate to double overnight. Penalties on fixed rate mortgages Each lender has a different way of calculating the cost to break a mortgage. However, generally speaking, breaking a variable rate mortgage will cost roughly three months of interest or approximately 0.5% of the total mortgage balance. While breaking a fixed rate mortgage could cost upwards of 4% of the total mortgage balance should you need to break it early and you’re required to pay an interest rate differential penalty. For example, on a $500k mortgage balance, the cost to break your variable rate would be roughly $2500, while the cost to break your fixed rate mortgage could be as high as $20,000, eight times more depending on the lender and how they calculate their interest rate differential penalty. The flexibility of a variable rate mortgage vs the cost of breaking a fixed rate mortgage is likely another reason you went with a variable rate in the first place. Breaking your mortgage contract Did you know that almost 60% of Canadians will break their current mortgage at an average of 38 months? And while you might have the best intention of staying with your existing mortgage for the remainder of your term, sometimes life happens, you need to make a change. Here’s is a list of potential reasons you might need to break your mortgage before the end of the term. Certainly worth reviewing before committing to a fixed rate mortgage. Sale of your property because of a job relocation. Purchase of a new home. Access equity from your home. Refinance your home to pay off consumer debt. Refinance your home to fund a new business. Because you got married, you combine assets and want to live together in a new property. Because you got divorced, you need to split up your assets and access the equity in your property Because you or someone close to you got sick Because you lost your job or because you got a new one You want to remove someone from the title. You want to pay off your mortgage before the maturity date. Essentially, locking your variable rate mortgage into a fixed rate is choosing to voluntarily pay more interest to the lender while giving up some of the flexibility should you need to break your mortgage. If you’d like to discuss this in greater detail, please connect anytime. It would be a pleasure to walk you through all your mortgage options and provide you with professional mortgage advice.