As interest rates start to creep up, homeowners with variable-rate mortgages are wondering whether to lock in to a fixed-rate one.
Since July of 2017, the Bank of Canada has increased interest rates four times, bringing the current rate to 1.5 per cent from 0.5. There is still speculation that there could be one more increase before the end of this year. The Bank of Canada has also given its neutral rate, or the rate that neither stimulates nor restrains the economy given current conditions, as 2.5 to 3.5, which some experts have predicted could come as soon as late 2019. The central bank’s rate affects banks’ prime lending rates. This affects variable-rate mortgage holders, whose payments are based on changing prime rates.
A CIBC survey from July reported 77 per cent of Canadians have a fixed-rate mortgage, where the mortgage rate is locked in and rates remain the same throughout the mortgage term, which shows the majority still favour fixed rates. But many in the mortgage industry still feel variable rates — which go up and down with the prime rate — have advantages over their fixed counterparts, such as lower monthly interest and more money going to the principal.
The survey also reported that though 72 per cent of Canadians believe interest rates will continue to rise over the next year, only 54 per cent of them would choose a fixed-rate mortgage and 19 per cent would go variable, leaving 26 per cent undecided.
We asked several mortgage brokers across the country to wade through the details and give us their take on whether this is the time to consider moving from a variable to a fixed mortgage.
Life is more variable than fixed
It’s simple: No one can predict what the next five years of their life will look like and this unpredictable nature could lend itself more easily to a variable mortgage, explains Sabeena Bubber, senior mortgage professional for Xeva Mortgage in North Vancouver, B.C.
“[Many] people don’t make it through a five-year term and the cost of breaking a five-year fixed [mortgage] with a chartered bank is a substantial amount of money,” says Ms. Bubbert.
Breaking a fixed mortgage can come with penalties equivalent to a year of payments, whereas a variable mortgage comes with a three-month penalty.
“People often can’t predict what’s going to happen in five years and they say they’re going to stay put, but things happen: death, divorce, downsizing … which may mean that five years [mortgage] needs to be broken at some point,” adds Ms. Bubber.
But each mortgage holder is different and must be assessed on a case-by-case basis, as mortgages are never a one-size-fits-all purchase, says Sarah Nixon-Miller, mortgage broker for Mortgage Group in Halifax.
“Variable-rate products and fixed-rate products both have their advantages and their drawbacks,” says Ms. Nixon-Miller. “So it really comes down to the client’s needs, their financial fitness, as well as their risk tolerance.”
Changes in life might also mean that a person’s risk tolerance is not as high as it was when they started the mortgage and that might mean a fixed rate to give peace of mind.
“Ups and downs in the market are natural when you look at historical variances of mortgage rates, so anyone in a variable-rate mortgage should be prepared to look at those ups and downs during the course of the term of their mortgage,” says Ms. Nixon-Miller. “Anything can change and if their risk tolerance has changed or there is anything that is making them uncomfortable, it might be a good time to consider locking in [to fixed].”
Nervous about a variable mortgage rate? Take a look at the whole picture
Jeff Sparrow, mortgage specialist at Castle Mortgage Group in Winnipeg, says he worries that people are getting caught up in the headlines about increasing interest rates and might be prematurely panicking over what he considers to be minor increases in their monthly mortgage payment.
“A quarter of one percentage point isn’t a hike,” explains Mr. Sparrow. “The noise gets translated into shock and awe and creates a frenzy about the largest payment most people make, but if you have a $200,000 to $300,000 mortgage, this might mean an increase of $20 per payment.”
His advice is that if this kind of payment increase makes an individual nervous, it could be time to take a more holistic approach to the household finances.
Excluding mortgages, Canadians carry an average of $22,800 each in debt and those between the ages of 46 and 55 have the highest average debt loads, at $34,100, according to credit reporting company Equifax Canada.
“Hopefully when the needle gets moved like this, it creates an opportunity to look at the whole picture and maybe say, ‘It’s not going to be the mortgage that’s going to be a problem, it’s the car loan and credit card payment,’ and these they need to pay off faster,” he adds.
Either way, pay like it’s fixed
“The recommendation that I make to my clients is to take the variable rate mortgage, but pay it as if it were fixed so that they pay their mortgage down faster,” says Ms. Bubber. “Instead of giving that interest and spread to the bank, they benefit themselves … by getting their balance down quicker.”
Some mortgages have penalties for paying faster or putting more on to the principal than is set out in the terms at the beginning of the mortgage, so it is important to read the fine print on the mortgage terms. “Good prepayment privileges should allow a borrower to pay at least 15-20 per cent of their original principal mortgage amount every year,” says Ms. Bubber, adding that ideally the lender would not have any restrictions on how often the borrower can make lump-sum payments.
The idea is to take as much of a bite out of the principal as possible.
“The best way to fight inflation [higher interest rates] is by debt reduction,” she adds.