Locking In a Variable Rate Mortgage

When mortgage interest rates were on a downward trend in the early days of the coronavirus pandemic, a variable mortgage rate made sense. With no signs of tightening on the horizon, the housing market boomed at extraordinary levels never seen before.

Now that interest rates are rising as the central bank attempts to rein in out-of-control price inflation, the discussion is how high mortgage rates will go. It is a crucial conversation, since rising rates will increase your monthly mortgage payments. While it’s challenging to forecast just how high mortgage rates will climb, Canada Mortgage and Housing Corporation (CMHC) thinks they will start to stabilize in 2024, which is when some market analysts expect the Canadian real estate market to normalize.

“Mortgage rates eventually start to stabilize in 2024. Supported by rising household income and higher immigration, house prices are expected to return to positive but moderate growth,” CMHC chief economist Bob Dugan said in a report. “Elevated price levels persist over the forecast horizon placing pressure on homeownership affordability. As referenced in CMHC’s Canada’s Housing Supply Shortages: Estimating what is needed to solve Canada’s housing affordability crisis by 2030, this would then lead to more pressure on the rental segment. Potential homeowners will stay renting longer, and rental vacancy rates will be even lower.”

Should homebuyers and homeowners ditch the variable rate mortgage in favour of a fixed rate, if rates are only edging higher? This is the main debate many market participants are having right now: Is it better to choose a fixed-rate mortgage or a variable-rate mortgage? Indeed, everyone is weighing the advantages and disadvantages of both.

Locking in a Variable Rate Mortgage

First, what is the difference between these lending instruments?

A fixed-rate mortgage means that your interest rate and payment will stay the same over the course of the mortgage term, be it three years or five years. (The five-year rate will typically follow the five-year bond rate.) This allows you to “set it and forget it” as you have certainty for the term.

A variable-rate mortgage fluctuates based on the market interest rate, also known as the prime rate. Therefore, payments will fluctuate when there are fluctuations in the prime rate. So, in other words, a variable rate will be quoted as Prime +/- a specified number. Surprisingly, variable rates have been less expensive over time.

Does this mean you cannot lock in a variable rate? No. Borrowers can lock in from the variable to a fixed rate at any time. While you can lock in at the present variable rate, it would be better for your pocketbook to lock in at the best fixed posted rate.

It should be noted that this transition could trigger a penalty since you are breaking your current mortgage agreement.

Meanwhile, making this giant financial leap also depends on risk tolerance.

“Some people feel more comfortable knowing that their interest rate (and therefore their mortgage payments) will remain the same. It certainly makes budgeting a lot easier,” wrote IG Wealth Management. “Switching, though, isn’t quite that clear-cut.”

Ultimately, all homebuyers and homeowners need to work with mortgage specialists to determine the most suitable decision for their budget.

Canadians Breaking Their Current Mortgages

In the end, a five-year fixed-rate 5.34 per cent mortgage with an amortization period of 25 years on a $623,000 mortgage will cost nearly $3,800 per month. On the other hand, a five-year open variable rate mortgage at 6.6 per cent would cost borrowers more than $4,200 a month.

With how the Canadian housing market has fluctuated in the last couple of years, it is not surprising that research shows that 60 per cent of Canadian mortgage holders will break their agreements to perhaps lock in a variable rate or for personal reasons.

Whether it is a worthwhile thing to do will depend on the individual household. Whatever the case may be, the mortgage market has been turned upside down now that the BoC is tightening monetary policy and putting the lid on easy money efforts. This makes borrowing more expensive, limiting how much families can take out to achieve their dreams of home ownership.

Every lending provider has its set of policies and ways of handling mortgages, whether fixed or variable. So, it is critical to do your homework, contact lenders, compare rates, and learn about the various terms and conditions.

This is the biggest purchasing decision of your lifetime, and the current rising-rate environment could add thousands of dollars to your mortgage payments every year. Put simply, crunch the numbers, speak with a mortgage professional, and figure out the dollars and cents of your household budget.