Mortgage renewals: Which is better, a fixed- or variable-rate?

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If you have a mortgage, chances are you’ll be renewing it in the foreseeable future. That’s because mortgage contracts are good only for a specified term, commonly three to five years. So, unless you’re nearly done paying off your loan, a new mortgage is in the cards for you.

Each time your mortgage comes up for renewal, you have lots of decisions to make: Will you stay with your current lender or switch to a different one? Should you go with a fixed or variable rate? Is it better to choose a shorter or longer term? You might also want to borrow additional funds or extend your amortization period (the time it takes to pay off the mortgage balance in full), which is called mortgage refinancing. Of course, you can also break and renegotiate your mortgage contract before the term is up, but you’ll pay for that privilege in additional fees.

Here’s what you need to know about the mortgage renewal/refinancing process so you can make the decisions that work best for you.

When do I renew my mortgage?

By law, banks have to send you a renewal notice at least 21 days before the end of your existing term. But lenders will typically let you renew a mortgage without penalty 120 to 180 days before your current term is up, and will often send you an early renewal offer during that period in an attempt to retain your business.

Should I accept my lender’s early mortgage renewal offer?

While you might feel compelled to take that early offer from your existing mortgage provider, especially if you’re worried interest rates could go up, it’s best to shop around.

According to Toronto mortgage broker David Larock, early offer renewal rates are usually uncompetitive, which means you’ll likely get a much better rate with a competing financial institution or by negotiating with your current provider. Either way, you may qualify for a discounted interest rate that is lower than the rate quoted in your renewal letter.

And don’t fall prey to common pressure tactics used by lenders, says mortgage strategist and Globe and Mail contributor Robert McLister. “Their retention personnel are trained to convince you that their early renewal promotion is a ‘limited-time offer.’ In truth, lenders commonly honour early renewal rates after the supposed ‘expiry date,’ as long as rates in general have not increased,” he says.

(To find out if there might be an imminent change to market interest rates, which affect mortgage rates, consult the Bank of Canada’s schedule of interest rate announcements, as these changes take place eight times a year on predetermined dates.)

How do I negotiate a better mortgage rate?

A few months before the end of your term, start shopping around even if you haven’t yet received a renewal letter. In the case of fixed-rate mortgages, many lenders will hold an interest rate for you for up to four months, which you can then use to negotiate with your existing mortgage provider. Just be sure to get the offer in writing, as your current lender may want proof of competing rates.

But keep in mind that the interest rate is just one aspect of your mortgage renewal. Borrowers should also look at any applicable fees and flexible features that help you port (transfer your mortgage to another property if you decide to move), refinance, break, convert or prepay your mortgage early at the lowest possible cost. “Those things usually save you more than a small difference in interest rates, sometimes dramatically more,” says Mr. McLister.

And, as Rob Carrick, The Globe’s personal finance columnist, noted in a June 2020 column, you never know when an unexpected event – like a pandemic – might force you to sell your home and bail on a mortgage. “This can happen even in good times – you get a job in another city or become ill and need to move to change your living arrangements,” he adds. Indeed, seven out of 10 Canadians end up breaking their mortgage early.

“By all means ask your bank for its best offer,” advises Mr. Carrick. “Then consult a mortgage broker to compare both the rate and the breakage penalty.”

Ron Butler, a mortgage broker at Butler Mortgage Inc., agrees that’s the right approach. “Shop the market first, so you have a concept of what the best possible deal is,” he says. “Then go back to your own bank and try to press them to give you that same best possible deal – with a reduced penalty.”

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Which is better, a fixed- or variable-rate mortgage renewal?

This is a personal decision that’s based, in part, on borrowers’ comfort level with the unknown and their financial ability to withstand potential increases in interest rates.

As this Mortgages 101 guide explains, fixed rates are usually higher than variable rates, but you get the peace of mind of knowing exactly what your payments will be for the entire mortgage term. A variable-rate mortgage, on the other hand, fluctuates based on movements in the Bank of Canada’s overnight rate. Depending on the details of your mortgage contract, those fluctuations will lead to changes either in your mortgage payment amounts, or your amortization period. Either way, rate changes on a variable mortgage affect how much interest you pay in the long run.

“The big decision facing people today is, ‘Should I lock in?’ ” says Ross Taylor, a mortgage broker and owner of Ross Taylor Mortgages in Toronto. “But I think the more important question people should be asking is, ‘What’s the best mortgage for my particular situation and risk tolerance?’ ”

That’s sound advice, since there’s no crystal ball to tell you which way interest rates will go. For what it’s worth, historical data point to variable rate mortgages as the “lower cost way to go, almost every time,” according to James Laird, co-CEO of loan comparison website Ratehub.

One thing is certain however: If you think you might need to break your contract mid-term for any reason, variable is almost always the better way to go since there are different formulas for calculating prepayment penalties on variable- versus fixed-rate mortgages. (Prepayment penalties are how the banks recoup some of the interest they’ll lose when you break your mortgage, or take it elsewhere.)

“On a variable-rate mortgage, generally, your penalty is three months of interest, which isn’t too bad,” Mr. McLister said in a recent episode of Stress Test, The Globe and Mail’s personal finance podcast. But with fixed-rate mortgages, your penalty is the greater of three months’ interest or what’s called the interest rate differential, which can vary dramatically from lender to lender. “In many cases, depending on the lender, your IRD penalty can be significant,” he says. “The Big Six banks, for example, have horrendous interest rate differential penalties.”

Is it better to renew with a shorter or longer term?

Again, there’s no right answer here. If you’re choosing a variable-rate mortgage, the term isn’t as important since you can convert to a fixed rate with your lender at any time without penalty, and you can even break your contract with limited prepayment penalties, as noted above. With a fixed mortgage, however, you need to think carefully about how you’d react if interest rates were to decrease significantly during your mortgage term.

For those who want to safeguard against further rate increases, but don’t want to commit long term to a fixed-rate mortgage, a shorter two- or three-year term might make sense, suggests Allison Van Rooijen, vice-president of consumer credit at Meridian Credit Union. But you also have to consider what your financial circumstances (and the economy) might look like when the term expires, and your mortgage comes up for renewal.

Will I have to pass the mortgage stress test when I renew?

The short answer is no, but only if you renew with your current provider. If you want to switch to a different bank or other federally regulated lender, you’ll be treated as a new borrower and will have to qualify at the higher stress-tested rate. That means the lender will review your income and debts to make sure you could afford your mortgage payments at a rate of either 5.25 per cent, or your contract mortgage rate plus two percentage points, whichever is higher. (As of August, 2022, even the best variable rates are north of 3.5 per cent, which means everyone subject to the stress test must now effectively qualify at the latter benchmark.)

See how rising interest rates will affect the cost of your mortgage

In other words, if a federally regulated lender (other than your current one) is prepared to offer you a five-year fixed rate of 5 per cent, you’ll have to qualify at 7 per cent. There is one exception, according to Mr. McLister: if you have a mortgage insured by Canada Mortgage and Housing Corp. that you got before the stress test was introduced on Oct. 17, 2016, some lenders can “grandfather” you and let you qualify at their actual five-year fixed rate.

What if I can’t pass the mortgage stress test?

If you want to switch mortgage providers at renewal, but you don’t qualify because of the stress test, there are a few options open to you.

In situations where you’ve had no luck qualifying for a fixed-rate mortgage, you could instead apply for the lender’s variable-rate mortgage, which should be significantly lower. “It’s a little workaround,” says Mr. Taylor. “You can [later] convert from variable to a fixed rate with the same lender without having to requalify.” Of course, you might not get the same fixed rate in future as what’s currently on offer, so there’s some risk involved.

You could also pay down some of your mortgage principal (or repay other debts, if you have a high debt-to-income ratio) to help you pass the stress test. Finally, credit unions are provincially regulated and therefore not bound by federal stress test rules, so you might be able to qualify with them even if you can’t with other lenders. “Many credit unions have flexible options that can be offered to borrowers outside of the traditional stress test,” says Ms. Van Rooijen. “A debt service ratio shouldn’t make or break a mortgage decision in isolation of other factors.”

Unfortunately, some borrowers will simply find they can’t borrow enough to qualify with another mortgage provider under the federal stress test rules and “will be trapped to stay with their lender,” says Mr. Butler.

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Is there any way to lower my mortgage payments at renewal?

If the recent interest rate hikes are giving you sticker shock now that it’s come time to renew your mortgage, you may be looking for ways to reduce your payments.

For those who have typically been fixed-rate borrowers, a simple way to get lower payments – at least temporarily – is to renew at a variable rate. But if you can’t live with that level of uncertainty, look beyond the traditional fixed or variable rate options to keep payments as low as possible, suggests Wendy Brookhouse, founder and chief executive officer of Black Star Wealth in Halifax. Some lenders offer tiered mortgages that break the principal loan into five pieces with fixed terms ranging from one to five years. “That way, every year, one-fifth of your mortgage is going to come up for renewal with the lowest possible rates,” she says.

Extending your amortization is another way to lower your payments, notes Mr. McLister. “Going from a 15-year to a 30-year amortization can cut your monthly payments by more than 30 per cent,” he says. “Some lenders can even refinance you into interest-only payments if your cash flow is tight, but you won’t like the interest rate.”

These changes, however, are not part of a straight mortgage renewal because they require you to modify your loan agreement. Instead, you would need to refinance your mortgage, as explained below.

What is mortgage refinancing?

Mortgage refinancing allows you to negotiate more terms and conditions than a mortgage renewal, including borrowing more money, adding a secured line of credit, changing the borrowers on title or increasing your amortization. In effect, you are doing away with your previous loan agreement and applying for a new mortgage – either with your current lender or a different one.

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Assuming you’re dealing with a federally regulated lender, that means you’ll be subject to the mortgage stress test – even if you’re refinancing with your existing mortgage provider. There may also be additional costs, such as appraisal, registration and legal fees. If you’re switching lenders, there could also be a mortgage discharge fee.

You can refinance your mortgage at any time, not just when it’s up for renewal. But if you refinance mid-term, you’d also be subject to prepayment penalties – even if you’re staying with the same lender.

When does it make sense to refinance a mortgage?

According to Mr. Butler, refinancing your home makes sense when there is a clear financial benefit. For example, some homeowners may want to refinance their mortgage to access a portion of the equity they’ve accumulated in their properties to finance renovations, pay off higher interest debt or invest.

“If you’re going to finish the basement and get a tenant – and that’s going to be a new revenue stream for you – there’s a sensible economic advantage,” he says. But he cautions against taking out money to make a down payment on a rental property or another type of investment, which he calls “using your home as an ATM.”

If you’re refinancing mid-term to take advantage of a lower interest rate, make sure you’ll come out ahead even after paying all prepayment penalties and other fees.

As far as refinancing to extend your amortization to keep payments down, Mr. Butler’s not a fan. That will not only have you paying more in interest over the long term, but can also lead to an “infinite economic debt cycle,” changing people’s financial lives and futures, he says.