Everyone Loves Variable Mortgages, Until the First BOC Rate Hike

Some mortgage borrowers’ confidence in variable rates may be tested as the Bank of Canada’s overnight target rate starts its inevitable climb upwards, perhaps as early as this week.

Recently, a client reached out to me, writing: “Are you able to provide further advice on when we should make the switch to a fixed rate—all the news seems to imply such a choice is becoming imminent.”

This is a perfectly legitimate question, and it’s one many mortgage borrowers have already asked.

Every day, mortgage borrowers are wondering if they should choose fixed or variable, given the coming rate hikes. And almost as often, once bold and brave variable mortgage clients are asking if they should switch to a fixed rate…and if not now, then when?

Here’s the thing…when you chose a variable-rate mortgage, you understood that the rate would vary. This means the rate may go up or down from time-to-time, but it’s impossible to expect it to remain constant for the duration of your mortgage term.

So, after years of falling and flat rates, borrowers are now about to get their first taste of a rate increase, and some are throwing their initial rate-selection logic out the window.

That may sound harsh, and in fact it’s not really how I feel because I’m a big believer in emotional health and well-being. I think that should be a huge factor in any borrower’s decision. That, and one’s ability to withstand payment hikes.

Why should you choose a fixed-rate mortgage?

If you simply don’t have the stomach for rate increases and varying monthly payments, you can give yourself instant peace of mind by fixing your mortgage rate. There is no shame, and no one can tell you it is the wrong decision.

For the risk-averse homeowner, mortgage expert Rob McLister wrote in a recent Globe and Mail column that, “a 5-year fixed makes sense for most long-term borrowers with less established finances. It also insures against the small but real risk that inflation is being drastically underestimated.”

McLister also made the case that a fixed rate can be beneficial for traditional property investors with a five-year plus holding period.

Where are interest rates actually headed?

Nobody truly knows where rates are going. Ever. Not even the best-paid government and bank and economists.

Mortgage Alliance broker Renee Matiushyk-Stribbell told me, “I’ve been doing this forever and liken these projections to be as accurate as the weatherman. No one can predict the future of rates because we have no idea what is going to happen in the local or global economy.”

She added, “Nine times out of 10, in the past when predictions like this came out, they were wrong. So, when people ask me about rate predictions, I tell them I have no idea and, in reality, no one does.“

The Bank of Canada drastically cut its overnight target rate in the early days of the pandemic, from 1.75% to 0.25% in March 2020. As a result, prime rate—upon which variable rates are based—fell from 3.95% to 2.45%, where it’s been ever since. And suddenly, a slew of homeowners experienced the thrill of variable-rate mortgages below 2% for the first time ever.

Since then, the party has been loud and boisterous, with more people choosing variable-rate mortgages than at any time in memory. And variable-rate mortgages today are routinely available under 1.50%, with some even under an unimaginable 1%. Current fixed-rate offerings of 2.79% or more are rendered pale in comparison.

Should you stick with a variable-rate mortgage?

Several big-name brokers make very strong and compelling arguments for why borrowers should hang tough, that with the spread between variable and fixed rates being so large, you can withstand many prime rate increases before you may be worse off.

Of course, there is no law stating that rate increases will be limited to 25 basis points at a time. They could be larger.

And let’s not forget, if you ever have to break your mortgage, you will enjoy the prepayment penalty on a variable (typically three months’ interest) much more than you will on most fixed-rate mortgages.

Mortgage broker Dave Larock of Integrated Mortgage Planners is always an excellent source of information about mortgage interest rates—I trust his opinion over most economists. Here’s his advice to those who are considering variable-rate options:

  • Commit to your strategy. Converting mid-term will almost always result in a higher fixed rate than is available today.
  • Set your payments as if you had taken a fixed rate. This will absorb the impact of several short-term rate bumps.

The takeaway

This is a personal decision – it’s for you to make, and not your banker, your mortgage broker, your real estate agent or your buddies. Do what makes sense for you and your finances. Be respectful of your partner’s views and find an approach you can both live with.

If you need help evaluating your situation, as Larock says, “there are many mortgage brokers and agents in the market, but only some of us stay on top of market conditions and can offer an educated opinion about ongoing variable-rate risk.”

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