Your lender offers you two options. The fixed rate is 5.50%. The variable rate is 4.75%. The variable is lower, so it feels like the better deal — like you're getting a discount.
You're not getting a discount. You're doing your lender a favour.
Banks don't offer lower variable rates out of generosity. They offer them because variable-rate borrowers take on a risk the bank would otherwise carry itself. Understanding exactly what that risk is — and what it costs when it goes against you — is the only way to make this decision with clear eyes.
This article explains both options in plain English, shows you real dollar scenarios, covers the penalty trap most buyers don't see coming, and explains a Canada-specific disaster that caught thousands of borrowers off guard in 2022.
What "fixed" and "variable" actually mean
A fixed-rate mortgage locks in your interest rate for a set term — typically 2 to 5 years in Canada, or the full loan duration (often 30 years) in the US. Your payment is the same every month for the entire term, regardless of what happens to interest rates in the broader economy.
A variable-rate mortgage ties your interest rate to a benchmark that moves with the economy. In Canada, that benchmark is the lender's prime rate, which follows the Bank of Canada's overnight rate. When the Bank of Canada raises rates, your mortgage rate rises too — often within days. When it cuts rates, you benefit just as quickly.
In the US, variable-rate mortgages are called ARMs — Adjustable Rate Mortgages. They work a bit differently: they typically offer a fixed rate for an initial period (5, 7, or 10 years), then adjust annually after that based on a market index. We'll cover the US version specifically later in this article.
In Canada there are actually two flavours of variable mortgage, and the difference matters enormously:
VRM (Variable Rate Mortgage): Your monthly payment stays the same dollar amount. But as rates change, the split between interest and principal shifts. When rates rise, more of your payment goes to interest — meaning less goes to actually paying down your loan. This is the type that caused the trigger rate crisis of 2022.
ARM (Adjustable Rate Mortgage — Canadian version): Your payment amount changes when rates change. If rates rise, your payment goes up. If rates fall, your payment goes down. More straightforward, but requires a more flexible budget.
Why variable rates are lower — and what you're giving up
Think of it like this. Your lender knows where rates are today. They don't know where they'll be in three years. That uncertainty has a cost — and the bank wants to be paid for carrying it.
When you take a fixed mortgage, the bank absorbs all the rate risk. If rates shoot up to 8% next year, you're still paying 5.50%. The bank loses out on what it could have charged you. To compensate for that risk, it charges you a higher rate upfront.
When you take a variable mortgage, you absorb the rate risk. The bank knows whatever happens, your rate will track the market. It doesn't need to build in as much cushion — so it charges you less. The lower rate is your compensation for taking on that uncertainty.
This doesn't mean variable is bad. It means there's a real trade-off. The question is whether the compensation (lower starting rate) is worth the risk (payments that can go up significantly if rates rise).
The numbers: what the difference actually looks like
Let's use a concrete example. $500,000 mortgage, 25-year amortization — typical for Canadian buyers, and a reasonable benchmark for US buyers too.
Fixed rate: 5.50%. Variable rate: 4.75% (starting).
| Rate scenario | Fixed payment | Variable payment | Monthly difference |
|---|---|---|---|
| Rates fall 1% (variable → 3.75%) | $3,071 | $2,571 | Save $500/mo |
| Rates unchanged (variable stays 4.75%) | $3,071 | $2,850 | Save $221/mo |
| Rates rise 1% (variable → 5.75%) | $3,071 | $3,148 | Pay $77 more/mo |
| Rates rise 2% (variable → 6.75%) | $3,071 | $3,455 | Pay $384 more/mo |
The variable rate only needs to rise by about 0.75% before it costs you more than the fixed. At a 2% increase — which is not unusual during a rate-hiking cycle — you'd be paying an extra $384 every month, or over $4,600 more per year.
Variable rates have historically outperformed fixed rates over long periods. Studies suggest variable-rate borrowers have paid less interest than fixed-rate borrowers roughly 70–80% of the time over the past 40 years. But that historical average doesn't protect you when you're in the 20–30% of the time when rates spike. And a rate spike early in your mortgage — when your balance is highest — hurts the most.
If your variable rate rose by $400/month tomorrow, could you cover it without panic? Not comfortably — just cover it? If the honest answer is no, variable is not right for you regardless of what rates are expected to do.
The penalty trap: the hidden cost of breaking a fixed mortgage
Here's what most articles skip over — and what trips up a shocking number of buyers.
About 60% of Canadian homeowners break their mortgage before the end of their term. They sell the house. They get divorced. They move for a job. They refinance to access equity. Life happens. And when it does, breaking a fixed mortgage can cost you a very large amount of money.
Breaking a variable mortgage costs you roughly 3 months' interest. On a $450,000 balance at 4.75%, that's about $5,300. Stings a bit, but manageable.
Breaking a fixed mortgage costs you the greater of 3 months' interest or something called the Interest Rate Differential (IRD). The IRD is the bank's way of recouping the income it loses when you leave. And it can be brutal.
The IRD = (your original rate − the current rate for your remaining term) × outstanding balance × years remaining.
Example: You have $450,000 remaining, 3 years left on your term, original rate of 5.50%, and current 3-year rates are 4.00%.
IRD = (5.50% − 4.00%) × $450,000 × 3 = $20,250
Compare that to the variable penalty: $450,000 × 4.75% ÷ 4 = $5,344
The fixed penalty is nearly 4× higher — and this is a conservative example. In practice, lenders use their posted rates (which are higher than discounted rates) in the IRD formula, making the penalty even larger.
The lesson: if there's any meaningful chance you'll move, sell, or refinance before your term ends, the fixed mortgage's lower penalty is a major factor in favour of variable — even if the rate itself costs you more.
The trigger rate: what happened to Canadian variable borrowers in 2022
This section is Canada-specific and describes something that doesn't have a direct equivalent in the US. If you're American, you can skip to the next section — but it's a useful cautionary tale worth reading anyway.
From March 2022 to July 2023, the Bank of Canada raised its overnight rate from 0.25% to 5.00% — one of the fastest rate-hiking cycles in Canadian history. Variable-rate mortgage holders saw their rates nearly double in under 18 months.
For borrowers with VRM-type variable mortgages (fixed payment, shifting principal/interest split), this created a specific crisis: the trigger rate.
The trigger rate is the interest rate at which your fixed monthly payment no longer covers the interest owing. At that point, 100% of your payment goes to interest — and none goes to paying down your loan. Your mortgage balance is actually growing instead of shrinking.
You borrow $500,000 with a VRM. Your starting rate is 2.50%, your monthly payment is set at $2,240.
Your trigger rate = ($2,240 × 12) / $500,000 = 5.38%
When rates hit 5.38%, every dollar of your $2,240 payment goes to interest. Your balance stops going down. If rates rise further, your balance actually increases — a situation called negative amortization.
At that point, lenders send a letter: pay a lump sum, increase your monthly payment, or lock into a fixed rate. Many borrowers in 2022–2023 received these letters with almost no warning and no financial cushion to respond.
Adjustable Rate Mortgages (ARMs) in Canada avoided this specific problem because the payment itself changes with the rate — there's no fixed payment to "trigger." But ARM holders faced a different shock: their monthly payment jumped dramatically in a short period.
The lesson for anyone considering variable today: know your trigger rate before you sign. Ask your lender what interest rate would cause your payment to stop covering interest. Make sure you could handle either a payment increase or a lump-sum request if rates moved significantly.
How this works in the US: Adjustable Rate Mortgages (ARMs)
American ARMs work quite differently from Canadian variable mortgages, and in some ways they're less risky — because they come with built-in caps.
A 5/1 ARM, for example, offers a fixed rate for the first 5 years, then adjusts annually after that. A 7/1 ARM fixes for 7 years. These are the most common types.
US ARMs also come with three types of caps that limit how much the rate can move:
- Initial cap: limits how much the rate can jump at the first adjustment (typically 2%)
- Periodic cap: limits how much it can change at each subsequent adjustment (typically 2%)
- Lifetime cap: the maximum it can ever rise above the starting rate (typically 5–6%)
So if you start with a 5/1 ARM at 5.25%, the worst-case scenario with a 5% lifetime cap is 10.25% — painful, but at least predictable. Canadian variable mortgages have no such cap.
ARMs make the most sense for buyers who are confident they'll sell or refinance before the initial fixed period ends. If you're buying a starter home and expect to move within 7 years, a 7/1 ARM lets you capture the lower rate without ever facing the adjustable period.
The stress test — and why it applies to both options
In Canada, every mortgage applicant must pass the mortgage stress test — you have to prove you can afford payments at your contract rate plus 2%, or 5.25%, whichever is higher.
This applies equally to fixed and variable mortgages. The key difference: with a variable mortgage, the buffer built into the stress test is your actual safety margin. If rates rise 2%, you've already proven you can handle it. If they rise more than 2%, you're in territory the stress test wasn't designed to protect against.
In the US, there's no national equivalent stress test, but lenders have their own qualifying standards — typically using the fully indexed rate (the index plus margin, not the teaser rate) to qualify ARM borrowers.
Fixed vs. variable: a plain-English decision guide
There is no universally right answer. But there is a right answer for your situation. Here's how to think through it.
You're on a tight budget with little room for payment increases. You're buying at the top of what you can afford. You sleep better knowing exactly what you owe every month. You plan to stay for the full term. Rates are historically low and likely to rise. Or you're in a 2-income household where losing one income would already be stressful.
You have a cushion — savings or income headroom that could absorb a $300–$500/month payment increase. You might sell or refinance before the term ends (lower penalty matters). You believe rates are likely to fall or stay flat. You're comfortable with uncertainty. Or the interest savings free up money you'll actually invest or save, not just spend.
One more thing to consider: you can almost always convert a variable mortgage to fixed at any time, without penalty, in Canada. You'll get your lender's current posted rate — not a discounted rate — but the option exists. You cannot as easily convert a fixed to variable mid-term.
That asymmetry means variable gives you optionality. If rates rise and you're uncomfortable, you can lock in. Fixed gives you certainty but no escape hatch.
Variable rates have historically been cheaper over long periods — but they require financial resilience and the ability to absorb rate shocks. Fixed rates cost more on average, but they buy certainty. The right choice is the one that lets you sleep at night and doesn't put your finances at risk if rates move against you.