In her keynote speech last week, Deputy Governor of the Bank of Canada, Sharon Kozicki, asserted that the Bank of Canada is "prepared to act forcefully" to bring inflation back down to 2% by using their monetary policy tools. However, she also confirmed that the Bank is cautious about tightening their monetary policy too quickly which could further promote inequality and hardships for some households.
"While we will watch developments with respect to households closely as we proceed, it's important to be clear: Returning inflation to the 2% target is our primary focus and our unwavering commitment. We have taken action and will continue to do so to return inflation to target, and we're prepared to act forcefully" - Deputy Governor - Bank of Canada, Sharon Kozicki, March 25, 2022: https://youtu.be/IlKh0yAJMOg
In light of Ms. Kozicki's speech, many economists are now predicting that the Bank of Canada will announce a 0.50% increase to their key policy rate in their April 13th announcement.
So...is now a good time to panic? Should you lock into a Fixed Rate Mortgage?
Fear of the unknown is a large driver in the mortgage market, and there is a reason why 3/4 of mortgages in Canada are Fixed Rate Mortgages. People find comfort in predictability...and so do the Banks.
But... Isn't it important to consider that the 1/4 of Canadians with Variable Rate Mortgages have been the big winners and paid less overall interest for over a decade?
Inevitably, rates will rise. The "emergency" low rates of the pandemic cannot last forever.
We cannot predict the future. However, what we CAN do is explore the past and learn FOR our future.
Let's look at some quick and easy numbers:
Let's say you have a $500,000 balance with a 25 year amortization and a 5-year closed Variable Rate Mortgage at Prime Rate minus 0.80% right now.
That 0.80% is called your "discount", and you will have your discount for your entire 5-year Variable Rate term.
With Prime Rate currently at 2.70%, this means that your current interest rate is 1.90% (2.70% - 0.80% = 1.90%), and your monthly payment is $2,095.01.
(In fact, your rate may even be lower...some of you may have been lucky enough to secure Variable Rate discounts over 1.0% recently!)
In contrast, current 5-year Fixed Rate Mortgages with many of the Big Banks have now risen to approximately 3.89% to 4.14%! With a $500,000 balance and a rate of 3.89%, these fixed rate payments would be $2,600.37.
Therefore, there is now an interest rate difference of nearly 2% between Fixed and Variable Rate Mortgages, and this amounts to a savings of $505.36 per month for Variable Rate Mortgage holders.
But...What if Prime Rate rises?
If the Bank of Canada acts "forcefully", as they say, and raises their key interest rate by a half percent in April (raising Prime Rate to 3.20%), this will drive your Variable Rate interest rate to 2.40%.
$500,000 at 2.40% = $2,217.99/month
$500,000 at 3.89% = $2,600.37/month
With a Variable Rate Mortgage, you would still be saving $382.38 per month.
Let's say that the Bank of Canada acts even more aggressively and raises rates to "pre-pandemic" levels. After all, Prime Rate in October 2018 went as high as 3.95%, and stayed that way until April 2020, when it dropped to 3.45% at the beginning of the pandemic.
In this scenario, even if the Bank of Canada raised their key interest rate and Prime Rate rose to 3.95%, your rate would still only be 3.15% (3.95% - 0.80%).
$500,000 at 3.15% = $2,410.25/month
$500,000 at 3.89% = $2,600.37/month
With a Variable Rate Mortgage, you would still be saving $190.12 per month.
Let's go back even further in time to our last recession from October 2008 to May 2009. Granted, the world has changed a lot since then, especially the real estate market! During this time period, Prime Rate rose to 4.50%.
In this scenario, even if Prime Rate rose to this past-recession rate of 4.50%, your rate would be 3.70% (4.50% - 0.80%) ...again, still lower than current 5-year Fixed Rates right now.
$500,000 at 3.70% = $2,557.07/month
$500,000 at 3.89% = $2,600.37/month
With a Variable Rate Mortgage, you would still be saving $43.30 per month.
Don't forget...what goes up must come down! If you look at historical Prime Rate changes over the last 14 years in the chart below, you will see that Prime Rate has fluctuated from as high as 4.50% to as low as 2.25%. With a Variable Rate Mortgage, remember that rates may rise and fall multiple times during the term of your mortgage. While rates may be high for a period of time during your mortgage term, you may actually pay less interest overall due to the period(s) of time where you saved interest (when Prime Rate was low).
As I have mentioned in previous posts, you can always mitigate the risk of rising rates by taking advantage of the savings NOW.
I would recommend that you put aside the $505.36/month into a savings account or use it to pay down your principal balance faster. This way, if/when rates rise, you will be ready.
(And, remember, if you have a STATIC Variable Rate Mortgage, your payments may not change at all.)
Still don't have the stomach to ride the Variable-Rate-Mortgage-wave? That's okay! The type of mortgage that you choose is entirely your decision and depends on your comfort level. A Variable Rate Mortgage is not for everyone.
If you feel more comfortable with a Fixed Rate Mortgage, then you should go for it. However, before you do, it's important to consider a few things:
>> Flexibility - Not all Fixed Rate Mortgages are built the same. Some Fixed Rate Mortgage penalties offer more forgiving penalty calculations if you ever need to get out of your Fixed Rate Mortgage contract. In general, many of the Big Banks and some Credit Unions include the "original discount" that you receive from their posted rates in their Fixed Rate Mortgage penalty calculations (called the IRD, or Interest Rate Differential), while others do not. Including the "original discount" into the IRD penalty calculation can increase the cost of the penalty.
If you are set on staying with a lender who includes the "original discount" in their IRD calculations, you may be better off considering the 3 and 4 year Fixed Rate options because the difference between the 3 and 4 year contract vs posted rates tend to be smaller than those of the 5-year Fixed Rates.
In contrast, the penalty to break a Variable Rate Mortgage is just 3 months of interest.
>> Qualification - Did you know that you now qualify for a larger mortgage if you take a Variable Rate Mortgage? The current government-mandated stress test stipulates that we must use "the higher of the contract rate + 2%, or the 5-year benchmark rate" for qualification. For Fixed Rate Mortgages, the rate used for qualification would be approximately 5.89% (3.89% contract rate plus 2%). For Variable Rate Mortgages that are still under 3.25%, the lenders can still use the qualifying rate at 5.25%.
>> Rate - Different classifications of mortgages have led to an array of interest rate offerings across the mortgage market. If your remaining amortization is below 25 years, if the original purchase price of your home was under $1,000,000, if you purchased your home with less than 20% down, and/or if you have a lot of equity in your home, there may be better rate options out there for you.
So, is it time to lock into a Fixed Rate Mortgage, or should you continue to ride the wave?
There is no crystal ball. Ultimately, the decision lies with you and your comfort level after arming yourself with the knowledge above.
Will rates rise? Yes, rates will rise someday. Perhaps someday soon.
Will rates fall? Yes, rates will fall someday.
I believe that the Bank of Canada will likely raise their key interest rate aggressively and quickly this year to try to curb inflation. However, I do not foresee them maintaining high interest rates for a long period of time and believe that we will see rates start to fall again next year. With current real estate prices, high amounts of indebtedness across the country, pandemic recovery, and many other global factors, I do not believe that a high-interest rate environment will be sustainable for our economy.
We're likely in for a bit of a ride but, with the right knowledge, tools, and a little bit of courage, I am confident that you can and will make a sound mortgage decision.
Please do not hesitate to ask if you have any questions! I'm happy to help!
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