Major lenders have hiked fixed five-year mortgage rates over the past few weeks in response to rising government bond yields, but new home buyers willing to take a gamble may be tempted by another option: declining borrowing costs for variable mortgages.
All of the biggest banks have widened the discounts offered on their variable-rate mortgages in recent days by between 10 and 20 basis points, putting variable rates in the range of about 1.5 per cent, according to Robert McLister, who tracks rates as mortgage editor at RATESDOTCA. (There are 100 basis points in a percentage point.)
Those discounts mean well-qualified clients of the major banks can now secure an uninsured variable rate mortgage, on average, at about a full percentage point below the prime rate of 2.45 per cent. That’s a much wider discount than the long-term average of 0.6 percentage points and is close to an all-time record for the largest banks, he said.
The latest moves in the mortgage market illustrate the challenges policy makers may face in relying on higher rates as a near-term mechanism to cool a housing market on fire across much of the country.
Variable rates were already among the cheapest financing available to Canadians on their homes, owing to the prime rate – which generally follows Bank of Canada moves – sitting just above its historic low of 2.25 per cent, set during the financial crisis. Those wanting an insured product can secure even lower rates. HSBC, for instance, is still advertising variables at 0.99 per cent on new mortgages.
Still, only about 10 per cent to 15 per cent of Canadians are choosing variables right now, Mr. McLister estimates. Most prefer the security of fixed products that are still offering interest rates near all-time lows at a time when worries are mounting over possible future inflationary pressures and bond yields that are rising to their highest levels in more than a year.
The five-year government of Canada bond yield – which heavily influences fixed mortgage rates – has approximately doubled since last fall to nearly 1 per cent.
This has ignited a rush of Canadians to get approved for fixed-rate mortgages to secure the lowest possible rates while they still can. While that’s been playing out, however, banks have been adjusting pricing on variables, seeking to maximize margins while balancing risk exposures in their mortgage business. Fluctuations since early February in derivative markets, which guide banks in setting their mortgage rates, have resulted in margins becoming more attractive for variable products than for fixed on a relative basis, Mr. McLister said.
“The point is, the variable rate discounts are exceptional right now, if you consider nothing else,” he said.
Variable rates are usually sold on five-year terms, leaving them vulnerable to higher rates over a long period of time. The prime rate is tied to the Bank of Canada’s target for the overnight rate, and the big risk is the central bank could tighten monetary policy sooner, and more aggressively, than many expect.
The bank left the target rate unchanged on Wednesday and reiterated that it does not expect to start raising rates until 2023.
But bond markets are pricing in the possibility that it could happen sooner, a scenario that wouldn’t take many corporate executives by surprise. On Tuesday, Royal Bank of Canada chief executive officer Dave McKay said inflationary pressures will force central banks to start raising interest rates as soon as next year.
All of the country’s six biggest banks, including National Bank of Canada, have hiked fixed rates at least once since Feb. 19, according to Mr. McLister. Toronto-Dominion Bank was the first to move, and five-year fixed rates at the big banks for well-qualified borrowers are now generally half a percentage point higher than variable rates.
Even more hikes in fixed rates are expected to follow.
“The five-year fixed rates haven’t fully adjusted yet to the spike on bond yields, so there’s certainly going to be more lenders making rate hikes in the near future,” Mr. McLister said.
“If you’re a well-qualified borrower, and you can pick any term, then mathematically you’re taking a bit more of a gamble with a variable rate at this point than a five-year fixed, particularly since we’re coming out of a recession with an astronomical amount of stimulus,” Mr. McLister said. He recommends borrowers choosing a fixed rate focus on lenders with reasonable prepayment penalties.
Indeed, many brokers urge caution when choosing fixed over variables, given that they usually come with higher fees if breaking a mortgage before the end of term.
Dave Currie, an agent with Monstermortgage.ca, said the widening spread differential between fixed and variable products is another good reason to go with variable. He’s now seeing spreads of as much as 0.65 of a percentage point. Up until about six weeks ago, the spread between fixed and variable was essentially zero.
“We’re steering people into variables more than ever before,” Mr. Currie said, adding that he’s been discussing with some clients the possibility of breaking their fixed terms and going with variable instead. The cost of breaking existing fixed mortgages tends to fall as prevailing fixed rates rise.