How to Navigate a Variable Mortgage Amid Rising Interest Rates
Recent interest rate hikes by the Bank of Canada may have some homeowners wanting to pull the ‘chute on their variable mortgages and lock into a fixed rate.
It’s understandable these changes, bracketed by high inflation and the economic uncertainty brought on by the war in Ukraine, would cause some to rethink how they’re financing their home. But is it necessary?
“Rates are cyclical,” says Scott Nazareth, a mortgage professional with mortgages.ca. “They don’t always go up and they don’t always go down, so it’s important you don’t make rash decisions out of fear.”
Here are some actions variable mortgage holders can take to help navigate what’s ahead.
But first, a history lesson
Unprecedented has been the word of the pandemic, especially when referring to the economic impact of COVID-19.
When the world was forced to shelter in place and economies slowed to a trickle, governments responded with historic social and economic programs to provide stability.
By May 2020, the Bank of Canada dropped its already-low key policy interest rate to 0.25 per cent to encourage borrowing and stimulate the economy. Banks capitulated by setting their mortgage rates at historic lows.*
At the time there wasn’t a significant difference between fixed-rate and variable mortgages. But that spread grew over the past two years, inching closer to 1.5 per cent today. Even though variable rates can and do change, depending on the Bank of Canada, they continue to stay lower than fixed rates at this time.
Granted, variable rates can only go up after being set to record lows in 2020. Meanwhile, those with a fixed rate mortgage are guaranteed the same rate for their borrowing term regardless of what the Bank of Canada does.
Still, it’s worth noting that variable mortgages have historically won the race. Even through fluctuating rates, variable mortgage holders have typically paid off their principal faster. This was true even before the pandemic.
Last month, however, we saw the Bank of Canada raise the overnight rate to one percent. It’s the second consecutive rate hike and the biggest in 20 years. That resulted in the highest borrowing rates since the pandemic began.
Interest rates are expected to go up even more thanks to inflation soaring above targets and the war in Ukraine.
Variable mortgage holders might be asking if they can afford a change in their rates, which currently hover around 2.7 per cent, depending on the lender.
Nazareth says they can.
“Every mortgage since 2017 has been stress tested,” he says. “That made people qualify at a rate of 4.65 per cent and more recently at 5.25 per cent. It’s not that you were qualifying at the edge of affordability to begin with.”**
Pay the Spread
To be sure, however, Nazareth recommends variable mortgage holders “pay the spread” between current variable and fixed mortgage rates.
In other words, don’t just pay the minimum required on your variable mortgage. Throw in the extra 1.5 per cent that you would pay on a fixed rate. Not only will you budget for interest rate hikes before they happen, you’ll hammer down your principal in the process.
Still fixated on switching to a fixed rate?
If you’re still leaning toward a fixed rate, Nazareth recommends looking elsewhere than Canada’s Big 5 banks.
Those mortgages come with huge penalties if you break the term to sell your home, renegotiate your mortgage or refinance for equity. That could be as much as $40,000 on a $700,000 mortgage, Nazareth warns.
Variable rate penalties are only three months interest, in comparison.
There is a workaround for those who still want a fixed rate mortgage, however. Nazareth suggests working with a mortgage broker to secure funding through a monoline lender.
Just like banks, monoline lenders are strictly regulated. However, they’re “not as aggressive on their penalty calculation so you can expect to pay less with a fixed rate from monoline lenders” should you need to break the term.
Nazareth also suggests choosing a shorter fixed-rate mortgage term, just in case interest rates go down again – which, as history has taught us, is bound to happen.
“No one can tell the future,” he says. “However, remembering what goes up must come down and vice versa should give you limited scope in the eye of the storm.”
* Bank of Canada lowers overnight rate target to ¼ percent. https://www.bankofcanada.ca/2020/03/press-release-2020-03-27/
** OSFI unveils new stress test rules. https://www.canadianmortgagetrends.com/2017/10/osfi-unveils-new-stress-test-rules/