Mortgage types and their effect on buy vs rent

The pieces of a mortgage

Rate type. A fixed rate stays the same for the term. A variable rate changes with the lender’s prime rate or a similar benchmark, and lenders handle those changes in different ways, for example by changing the payment or the amortization. Read your contract.

Term. The term is the length of the contract, often a few years. At the end you renew, switch lenders or pay off the balance. The renewal rate is not known in advance.

Amortization. This is the total number of years to repay the loan. A longer amortization lowers the payment but increases total interest. Insured mortgages are normally limited to 25 years, with 30 years available to first-time buyers and buyers of newly built homes (rule effective December 15, 2024; confirm eligibility).

Compounding. Canadian fixed-rate mortgages compound semi-annually by law. Variable rates are typically quoted with monthly compounding. The engine models both.

Compounding: a small difference

The engine’s defaults describe a $600,000 home in Alberta with 20% down, a 4.5% rate, a 25-year amortization, a five-year term, rent of $2,300 a month and a ten-year hold. All figures are illustrative.

With semi-annual compounding the monthly payment is $2,656.67 and buying finishes $41,686 ahead of renting after ten years. With monthly compounding at the same quoted rate the payment is $2,668.00 and the result is $39,379. The difference is small, but it is a reminder to compare mortgages on the same compounding basis.

Amortization: lower payment, higher cost

A longer amortization reduces the monthly payment and slows equity growth. The table shows the same $600,000 home at three amortizations, with a 4.5% rate.

Because both households spend the same total housing budget in the model, a lower payment means the buyer has more left to invest, and the net difference in the ten-year result is small. The bigger difference is in the balance still owed: about $383,917 on a 30-year amortization against $292,537 on a 20-year one.

Renewal: the rate you do not know yet

With a five-year term and a ten-year hold, half of the ownership period is priced at a rate that is not yet known. In the model, the renewal rate defaults to the same as the contract rate. Changing it shows the exposure.

If the renewal rate is 6.5% instead of 4.5%, the ten-year result falls from buying ahead by $41,686 to renting ahead by $2,113, and interest paid rises from $187,048 to $226,835. If the renewal rate falls to 3.0%, the result improves to buying ahead by $73,823. A mortgage that starts at 3.9% and renews at 5.9% leaves buying ahead by $30,995.

No one knows the rate in five years, so test several. See mortgage renewal risk and interest rates and buy vs rent.

Term length and the cost of leaving early

If you sell before the end of the term, you may pay a prepayment penalty unless you can transfer the mortgage to a new home. The engine estimates a penalty of three months’ interest when the sale falls between renewals. Real penalties depend on the contract, and for fixed rates they can be larger.

Matching the term to the horizon helps. Suppose you expect to sell after three years. With a five-year term the sale costs about $35,462 and the result is -$19,514. With a three-year term, which ends at the sale, there is no penalty, so selling costs are about $30,440 and the result is -$14,491. That is a $5,022 difference in this example. A shorter term also means an earlier renewal at an unknown rate, so there is a tradeoff.

How to use this

Decide first how long you expect to stay, then choose a term that fits. Use the mortgage payment tool to compare payments and the main calculator to test renewal rates. Remember that the mortgage decision is separate from the buy vs rent decision. A good mortgage cannot make a poor purchase worthwhile, and a pricey one does not make renting the winner by itself.

For the financing rules that apply to small down payments, see CMHC insurance and buy vs rent. For the cost of leaving, see selling costs and buy vs rent.