Uncertainty is everywhere in the financial world these days as the COVID-19 pandemic spreads, and that’s translating into big swings in mortgage rates and challenges in how to navigate borrowing for a home.
Given the lack of economic clarity, brokers says it’s important to keep a close eye on rates if you’re in the market, since they could continue to fluctuate widely and banks take different approaches to fixed and variable rates.
Fixed rates started to fall noticeably in late February as the bond market reacted to the economic threat of the virus. Then in early March, the Bank of Canada followed the U.S. Federal Reserve in slashing rates by 50 basis points, and then did so again in mid-March and added another taper at the end of the month.
“What we saw in the past, let’s just say three weeks, was a unprecedented accumulative drop in that key rate of over one and a half per cent,” said Toma Sojonky, a mortgage adviser in Vancouver.
The key central bank rate cut, which has pushed the prime rate from 3.95 per cent to 2.45 per cent, has made variable rates lower and mortgages more affordable.
“This could be good news for one element of the Canadians’ pocketbook, but it’s reflective of what of course is going on economically,” said Sojonky.
Banks haven’t passed on the full reduction of the prime rate in variable mortgages though because of the economic uncertainty and concerns about their liquidity, or the amount of money they have to lend out, as Canadians deposit fewer paycheques.
“Banks are at risk to have liquidity and potentially insolvency, and so banks have to maintain a percentage of liquidity or cash,” said Sojonky.
The increasingly cloudy economic picture that has pushed the prime rate down has also led banks to reverse their cuts to fixed rates and instead push them up, even to levels that were higher than when the crisis began, as banks become more cautious about lending and liquidity.
Rising fixed rates as prime rates fall is unusual, and reflective of how much uncertainty banks have on the direction of the economy, said James Laird, co-founder of Ratehub.ca and president of CanWise Financial.
“They don’t have a good feeling for how sharp the economic downturn is going to be, what our unemployment rate will get to, how quickly will we bounce back from it. So they’re building a higher risk premium into this fixed rate than what you would see during more usual times.”
Fixed rates could look more attractive when the world gets the pandemic under control, and the challenge becomes a more straightforward economic one, said Laird.
“The more we get into a regular recession, which people understand, you can expect that risk premium to disappear from fixed rates.”
But if borrowers think that the crisis will be protracted, then they should probably stick with variable rates for now, he said.
“If they think it’s going to be long and they think we’re going to get into a deep recession here, variable rate is the way to go because it will stay very low while we are in this mess.”
Because variable rates are now generally lower than fixed rates, a switch from the situation for the past year, Sojonky recommends those shopping for new mortgage or renewing one to go for a variable rate.
The option also has the advantage of having generally lower penalties than fixed-rate mortgages for breaking a mortgage, which quite a few Canadians end up doing, said Sojonky.
Variable-rate mortgage holders should then watch the market closely for changes in the outlook, or develop a good relation with a broker, to be ready to lock in a fixed rate if things change quickly.
“The good thing about variable rate mortgages is their optionality. And that as a fallback, Canadians have the option of locking into a fixed rate term.”
Be smart with your money. Get the latest investing insights delivered right to your inbox three times a week, with the Globe Investor newsletter. Sign up today.