Break-Even Rate

A break-even rate is the interest rate at which a borrower is indifferent between two mortgage options, meaning both options yield the exact total borrowing cost over a defined period.

Break-Even Rate – Quick Facts

• Identifies the interest rate at which 2 mortgage options cost the same
• Most commonly used to compare fixed-rate and variable-rate mortgages
• Helps borrowers assess interest rate risk rather than predict rates
• Based on assumptions about future interest rate movements
• Changes as market conditions and rate expectations shift

What Is a Break-Even Rate?

A break-even rate is a benchmark used to compare the costs of 2 mortgage options, typically a fixed-rate and a variable-rate mortgage. It identifies the future variable interest rate at which the total interest paid under both options would be equal over the same time horizon.

Rather than forecasting where interest rates will go, the break-even rate quantifies how much variable rates would need to rise or fall for the cost advantage to shift from one option to the other. This type of comparison allows borrowers and lenders to evaluate mortgage options against a measurable threshold rather than relying on assumptions or market sentiment.

Why Does the Break-Even Rate Matter for Canadian Mortgages?

The break-even rate matters for mortgages as it helps borrowers understand the trade-off between payment stability and interest rate risk. Fixed-rate mortgages provide cost certainty and predictable payments, while variable-rate mortgages expose borrowers to changing interest costs over time. The break-even rate shows how much variable rates can increase before the fixed option becomes equally costly.

If the break-even rate is well above the borrower’s current variable rate, it suggests that variable borrowing may remain cost-effective unless interest rates rise meaningfully. If the break-even rate is close to the current variable rate, a fixed-rate mortgage may offer better protection in an uncertain interest rate environment.

How Does the Break-Even Rate Compare to Other Rate Measures?

Fixed Mortgage Rates

Fixed mortgage rates remain unchanged for the duration of the term. The break-even rate is the average interest rate at which variable rates must rise for the total cost of a variable-rate mortgage to match the known cost of a fixed-rate mortgage over the same period.

Variable Mortgage Rates

Variable mortgage rates move with the lender’s prime rate. Canadian mortgage lenders price most variable-rate mortgages as prime minus a discount rather than a standalone rate. The break-even rate helps borrowers assess whether the expected path of prime rates makes the variable option more or less cost-effective than a fixed rate.

Adjustable-Rate Mortgages

Adjustable-rate mortgages are a type of variable-rate mortgage in which payments adjust immediately when the prime rate changes. Unlike static-payment variable mortgages, adjustable rates transfer both interest rate risk and payment volatility to the borrower. When evaluating break-even rates, borrowers must consider not only total interest costs but also their ability to manage fluctuating monthly payments.

How Do Lenders Use the Break-Even Rate?

Lenders and mortgage professionals use the break-even rate as a benchmark and educational tool in mortgage discussions. They use these comparisons to show how changes in interest rates affect monthly payments and total interest costs across different mortgage structures.

Lenders do not use the break-even rate for mortgage qualification or underwriting. Instead, it supports conversations about risk tolerance, payment variability, and how different mortgage options may perform under changing economic conditions.

How the Break-Even Rate Works in Practice

The break-even rate compares a known fixed mortgage cost with a projected variable mortgage cost over the same period to identify the point at which the total interest cost is the same for both options.

Step 1: Identify the fixed and variable mortgage comparison options.

For example, a borrower is choosing between a 5-year fixed rate of 4.50% and a variable rate starting at 3.75% on a $600,000 mortgage with a 25-year amortization.

These assumptions establish the loan size, time horizon, and rate structures required to compare total interest costs consistently.

Step 2: Calculate the total interest cost of the fixed-rate mortgage over the comparison period.

At a 4.50% fixed rate with a 25-year amortization, the borrower makes the following payments over the first 5 years:

• Monthly payment ≈ $3,333
• Total payments over 60 months ≈ $200,000
• Principal reduction over 5 years ≈ $53,000
• Total interest paid ≈ $147,000

This $147,000 represents the fixed-rate benchmark. The break-even analysis uses this amount as the target that the variable-rate option must match.

Step 3: Estimate total interest costs for the variable-rate option across different rate levels.

For the variable option, the analysis does not assume a specific month-by-month rate path. Instead, it solves for the average effective variable rate over the 5-year period that would generate the exact total interest cost.

At an average variable rate of 3.75%, the borrower pays approximately $120,000 in interest over 5 years, which is well below the fixed-rate cost. As the average variable rate increases, total interest paid also increases.

At lower average rates, the variable option remains cheaper than the fixed option. At higher average rates, the variable option becomes more expensive.

Step 4: Identify the break-even rate.

If the variable rate averages approximately 4.90% over the 5-year term, the borrower pays roughly $147,000 in interest, matching the total interest paid under the fixed-rate mortgage. That average variable rate represents the break-even rate.

If the average variable rate over the 5 years stays below 4.90%, the borrower pays less total interest than with the fixed-rate option. If the average variable rate exceeds 4.90%, the borrower pays more total interest, making the fixed-rate mortgage the more cost-effective option.

The break-even variable rate is above the fixed rate because variable mortgages typically start at a lower rate, reducing interest costs early in the term. Rates must rise enough, and remain elevated long enough, to offset those early savings.

The break-even rate does not predict future interest rates. It defines the tipping point at which the cost advantage shifts from one mortgage option to the other.

Common Mistakes and Misunderstandings for the Break-Even Rate

• Assuming the break-even rate predicts future interest rate movements
• Believing that lower current variable rates automatically lead to lower total cost
• Treating the calculation as static when interest rate expectations change
• Overlooking how payment frequency and prepayment behaviour affect interest costs
• Assuming lenders rely on break-even rates for approval decisions

Frequently Asked Questions (FAQ) About the Break-Even Rate

Related Terms

 • Fixed-Rate Mortgage
• Variable-Rate Mortgage (VRM)
• Adjustable-Rate Mortgage (ARM)
• Prime Rate
• Interest Rate Forecast
• Yield Curve