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Personal Finance Goodbye, variable-rate mortgage. Everyone’s going fixed these days, and for good reason

Only the most dedicated variable-rate mortgage fans are staying loyal today.

Everyone else is moving over to fixed-rate five-year mortgages. Mortgage agent David Larock says 95 per cent of clients are choosing a fixed rate, compared with a 50-50 split between fixed and variable last summer. Mortgage broker Sandra Epstein says she’s doing almost exclusively fixed rate, while broker Mike Bricknell said fixed rate accounts for 90 per cent of his business right now.

“Everything is kind of funnelling into the five-year fixed-rate mortgage,” Mr. Larock said.

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Variable-rate mortgages have for decades been the savvy home owner’s go-to choice. You typically pay a lower interest rate for a variable rate compared with a fixed rate, and your borrowing costs adjust lower or higher when the Bank of Canada changes its trendsetting overnight rate. When interest rates plunged after the last recession, variable-rate mortgages were the place to be.

The Bank of Canada began nudging rates higher in summer 2017, but variable-rate mortgages held their own with borrowers. The 2018 Annual State of the Residential Mortgage Market in Canada study by Mortgage Professionals Canada shows that 30 per cent of mortgages purchased in 2018 had a variable rate and that 27 per cent of all mortgages were in this category.

For the moment, homeowners are largely avoiding variable-rate mortgages. Driving this trend is our slow-growth economy and its effect on interest rates. We now have short-, medium- and long-term interest rates that are very close to each other. Normally, rates step higher as you go from short- to medium- and long-term.

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Variable-rate mortgages are influenced by short-term rates, while fixed-rate mortgages take their cue from longer-term rates. If both these rates are similar, the cost advantage of variable-rate mortgages fades.

Variable-rate mortgages were going for 2.95 per cent at a couple of national mortgage brokerage firms at midweek, while five-year fixed-rate mortgages were 3.09 per cent and 3.14 per cent. “When the difference between variable and fixed rate is this narrow, I just don’t think the risk-reward trade-off is compelling,” Mr. Larock said.

The usual gap between variable and fixed rates saves you money on interest, and it provides you with a margin of safety. The CMP study found that five-year variable-rate mortgages were on average 0.55 of a percentage point cheaper than five-year fixed-rate mortgages last year and 0.7 of a point cheaper in early 2019. With this differential on rates, the variable-rate mortgage remains cheaper than a fixed rate even if the Bank of Canada’s overnight rate rises a couple of times.

One reason to still consider variable-rate mortgages is that you believe the economy’s weak spell in early 2019 signals a slump that will require the Bank of Canada to cut rates. Mr. Larock said it’s possible this happens and that variable-rate mortgage holders end up saving money. His complaint about variable-rate mortgages is that there’s not currently enough reward to offset the risk of higher rates down the line.

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Another reason to go variable, at least with a big bank supplying your mortgage, is that you might need to break your mortgage before the end of its term. The penalties for breaking a fixed-rate mortgage at a big bank are unconscionably large, but penalties on variable-rate loans are more modest. Note: Mortgage lenders accessible through brokers often have more reasonable penalties for breaking fixed-rate mortgages than big banks.

Mr. Bricknell, the mortgage broker, said some lenders are offering deals on three-year fixed-rate mortgages that undercut five-year fixed rates. One major bank had a special rate this week of 3.19 per cent for a three-year fixed-rate mortgage and 3.29 per cent for a five-year fixed.

But for the most part, today’s quirky interest-rate environment has ruined short-term fixed-rate mortgages as a way to save money over a five-year term. At those mortgage brokerage firms mentioned earlier, fixed terms of one through four years were more expensive or identical to fixed five-year rates.

When interest rates return to a normal, expect variable-rate mortgages to regain their appeal. For now, homeowners seem to agree that fixed is better.

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