Your Guide to 3-Year Variable Mortgage Rates

Your Guide to Getting the Best 3-Year Variable Mortgage Rates

If you are searching for the best 3-year variable mortgage rates, comparemortgages.ca is the top choice for borrowers across Canada. We have the resources and understanding of mortgages that can help you complete the process of securing a mortgage in Canada. When opting for a variable-rate mortgage, you could face changing interest rates during its duration.

Compare 3-Year Variable Mortgage Rates

Why Choose a 3-Year Variable Mortgage Rate?

A 3-year variable mortgage term provides you with the opportunity to re-assess your financial situation sooner. As a borrower, you could make adjustments without a long-term commitment. Historically, variable interest rates tend to stay lower than fixed rates, resulting in more savings. Additionally, variable rates typically are limited to a  3-month interest penalty calculation if you should need to break your mortgage before your term ends. 

With a variable rate, the interest portion of your mortgage payment can fluctuate over time with changes in the market. This can be beneficial if interest rates are expected to decrease in the coming years. By choosing a variable rate, you could take advantage of lower interest rates if they drop during your term, potentially saving thousands of dollars over the life of the mortgage. 

How are 3-Year Variable Mortgage Rates Priced?

Variable-rate mortgages fluctuate with the prime rate (the benchmark interest rate banks and lenders use as the starting point when setting interest rates on their variable-rate loans, lines of credit, and variable-rate mortgages). 

The prime rate mirrors the movement of the Bank of Canada’s (BoC) key policy rate over your 3-year mortgage term and will vary with the performance of the Canadian economy. 

Economic indicators such as growth (measured with a comparison of the percentage of gross domestic product changes between a period of time) and inflation (measured with the percentage of consumer price index increase as a comparison between months, quarters and years) are used as tools to measure the economy’s trajectory.  

Interest rate is the fee that lenders charge throughout the mortgage term. Interest rates set by banks and lenders differ from those set by the BoC. 

The BoC sets a baseline interest rate twice every quarter (the Key Overnight Target Rate), which is used to lend money to banks. Banks typically add a spread of 2.20% to this baseline rate and call it their prime rate. 

What Drives Changes in 3-year Variable Mortgage Rates?

A few key players in the market drive changes in 3-year variable mortgage rates. One of these is the Bank of Canada’s overnight target rate. The overnight target rate dictates the cost of borrowing for financial institutions and impacts the rates of variable mortgages. 

Economic factors, such as inflation, employment rates, and GDP growth, also play a role. Changes in these market indicators can influence the Bank’s decision to fluctuate the overnight target rate with a direct impact on lender’s prime rates,  alongside changes to bond yields which affect fixed mortgage rates. Plus, global events, such as instability in foreign markets, health pandemics or natural disasters, can increase costs and risks causing a shift in interest rates.

The Two Variable Mortgage Types

There are two types of variable mortgages: variable-rate mortgages (VRM), which have fixed payments and fluctuating interest rates, and adjustable-rate mortgages (ARM), which have adjustable payments with fluctuating interest rates.

Variable-Rate Mortgage – Fixed Payments with a Fluctuating Rate

Variable-rate mortgages (VRM) have fixed payments that do not fluctuate with changes in interest rates over the mortgage term. 

• Since payments remain the same, any increase in the interest rate will mean more of the payment goes toward the interest portion and less to the principal. 
• Any decrease in the interest rate will mean more of the payment goes toward the principal and less to the interest. 

• An increasing interest rate will prevent the principal balance from being repaid and could increase your remaining amortization. Though this occurs infrequently, when rates go up significantly, they can cause this type of mortgage to become over-amortized, known as negative amortization. This means that when your 3-year term ends, you may have added additional years to your remaining amortization.
• If interest rates decrease over the term, more of your payment will go toward the principal. This means you will pay off your mortgage faster and lower the remaining amortization at the end of your term. Past market cycles have dictated that, generally, rates have a downward trend creating interest cost savings for those who choose to go with a VRM.

Adjustable-Rate Mortgage – Adjustable Payments with a Fluctuating Rate

Adjustable-rate mortgages (ARM) have adjustable payments that fluctuate with changes to the interest rate over the mortgage term. 

Since the principal portion of your mortgage payment stays the same throughout the mortgage term, the interest portion will fluctuate with changes to your lender’s prime rate. 

• With each change to interest rates, your mortgage payments will increase or decrease with the interest rate. Your amortization will reduce chronologically over your mortgage term unless you make a prepayment to the remaining principal balance on your mortgage. 

Why 3-Year Rates Are Rising in Popularity 

3-year rates are rising in popularity due to the expectation that interest rates will decrease once again within the next 3 years. Not locking into a longer-term fixed rate means borrowers who come up for renewal sooner could lock into a lower interest rate on a shorter term. Borrowers coming up to their maturity could choose a  variable rate if they expect rates will continue to fall. 

Benefits of Variable Mortgages

With variable-rate mortgages, if interest rates decrease, more of your payment will go directly toward paying down the principal amount of your mortgage. This means you will pay less interest on your mortgage throughout your term.   

It’s cheaper to break a variable-rate mortgage as lenders are limited to a 3-month interest penalty calculation versus the interest rate differential (IRD) calculation that is often used for breaking a fixed-rate mortgage.

Disadvantages of Variable Mortgages

There are a few disadvantages of variable-rate mortgages, but these disadvantages differ based on your variable mortgage type. 

VRM Mortgages

There are 3 risks with this type of mortgage: payment shock, hitting your trigger rate or reaching your trigger point. 

Payment Shock

Unlike ARM mortgages, payment shock on a VRM mortgage won’t appear until you’re up for renewal. 

• If rates are increasing and your mortgage payments are not, your mortgage runs the risk of negative amortization. This means at renewal, most of your mortgage payments would have been going toward the interest portion of your mortgage payment. 
• In some cases, only the interest may be paid for some time, leaving your amortization and principal balance to exceed your expected repayment schedule. This type of over-amortization is also known as negative amortization. 

Your new payments at renewal will be based on the remaining mortgage balance and the amortization reduced by your term. 

• If you started your mortgage term with a 25-year amortization, you should have 22 years left at the end of your 3-year term. 
• If your mortgage has over-amortized during your current term, you could have 30 years left to pay off. At renewal, your amortization will need to be rolled back to the 22-year remaining amortization period, causing your monthly payments to increase drastically, aptly named payment shock.

Trigger Rate

The trigger rate is reached when your fixed payment no longer covers any principal portion of your mortgage. This means that only the interest is paid with each mortgage payment as the interest rate increases while the principal portion remains untouched. If you hit your trigger rate before renewal, some lenders may offer to re-adjust your payments similar to when you renew to bring your amortization back to where it should be.  

If you find yourself in this situation, you can proactively reach out to your lender to either renew your mortgage and adjust the payment so you continue to make payments toward the principal, prepay a lumpsum amount toward the principal to keep your monthly payments the same, or you can increase your payments and prepay some of the principal to take advantage of both options available.

Trigger Point

The trigger point is reached when the balance owing on your mortgage becomes more than the mortgage amount that was initially lent to you. 

This occurs as your monthly mortgage payments are entirely going toward the interest portion of the mortgage. As interest repayments take away more of the equity you have built up by paying off the principal of your mortgage, you will eventually hit a point where the balance owing on your mortgage is more than the original amount. 

When this occurs, your lender must get your mortgage back by either having you make a principal prepayment to cover the additional ballooned balance, increase your payments so that a portion of your payment is going toward the principal, or refinance your mortgage with an increased amortization.

ARM Mortgages

The only real risk with this type of mortgage is continuing payment shock if the prime rate rises swiftly during your term, as your payments will adjust with each increase in interest rates. If interest rates rise in quick succession, the interest component of your monthly mortgage payments can significantly increase.  

Open vs Closed Mortgages

Open mortgages offer the flexibility of prepaying any amount toward your mortgage principal balance at any time without prepayment penalties. However, interest rates on open mortgages are generally higher to make up for this flexibility as there is increased potential that lenders will lose out on collecting interest if the borrower pays out (or transfers, switches or early renews) the mortgage sooner than anticipated. 

Closed mortgages limit your prepayment options from nil to a percentage of your original mortgage amount. If you pay off more than this annual limit, you will be charged a prepayment penalty calculated similarly to paying off your mortgage before your term ends. Closed mortgages generally have lower interest rates when compared to open mortgages to account for the limitations on prepayment privileges.

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