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Many experts believe variable rate mortgages offer the greatest potential for long-term savings on interest costs. Yet as the Bank of Canada increases interest rates, the short-term reality is that those with variable rate mortgages are seeing their interest costs go up. So what happens next?

Since March 2022, the Bank of Canada has been taking steps to raise interest rates in an effort to reduce inflation, cool the demand for goods and services and, in turn, make everyday life more affordable for Canadians. For homeowners with variable rate mortgages, there is justifiably some uncertainty about the immediate and long-term impact of rising rates on their mortgage and finances.

Understanding the fundamentals behind variable rate mortgages and the effects of interest rate changes on your mortgage can help you make informed financial decisions that are best for you and your family.

A backgrounder: How do variable rate mortgages work?

Payments remain the same with standard variable rate mortgages regardless of fluctuating interest rates. When rates go down, more of the payment goes to the principal amount and less towards interest, enabling mortgage holders to pay off the mortgage sooner. When rates go up, the reverse happens: less of the mortgage payment goes towards the principal and more to interest, extending the amortization period to pay off your mortgage.

When it comes time to renew a standard variable rate mortgage, the amortization schedule will be returned to its original timeline, resulting in a larger payment to compensate for the principal that would have been paid down had interest rates not increased.

Your mortgage options

If you’re concerned about the impact of changing rates on your mortgage costs and/or the pace at which you’re paying it off, there are a few ways you can help offset the effects of this rising rate environment.

1. Increase the amount of your regular mortgage payment

Increasing your mortgage payment can help reduce your principal mortgage balance, effectively lowering the impact of the increased interest rate. For example, with an RBC Variable Rate Mortgage, you can increase your regular mortgage payment by 10%. You may also be able to “Double Up” each payment by a minimum of $100 to a maximum of double the regular payment amount.

2. Make an annual lump sum payment

If you have the available funds, an annual lump sum payment is a great way to help save on interest costs while shortening the length of your mortgage. Be sure to check if your lender applies the lump sum payment to your principal mortgage balance and not the interest.

3. Switch to a fixed rate mortgage

This option may appeal to homeowners who feel more comfortable with a fixed rate that is locked in, as it protects against any future rate changes and keeps the amortization timeline on track.

Most lenders allow their mortgage holders to switch from a variable rate mortgage to a fixed rate mortgage equal to or greater than their remaining term. For example, if you have two years and four months remaining on your variable rate mortgage, you can switch to a three-year or longer fixed rate mortgage.

Bottom line

Homeowners with variable rate mortgages may be concerned about the impact rising rates can have on their finances, but it’s important to understand there are options available to help ease the uncertainty. A mortgage specialist can provide advice and answers to help you manage your mortgage and make short-term and long-term plans that can offer confidence and stability.