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Regardless of expectations, the market compensates borrowers for taking risk. Over a five-year span, the risk-reward of taking back-to-back one-year fixed mortgages remains favourable.Sean Kilpatrick/The Canadian Press

Mortgage shoppers are increasingly convinced the Bank of Canada will cut rates within a year. That’s leading most to avoid locking in long-term.

Problem is, short-term rates are high relative to those longer mortgages that borrowers are trying to avoid. The lowest nationally available uninsured one-year fixed is 5.74 per cent, for example, versus 5.09 per cent for a five-year fixed.

Higher one-year rates reflect investor expectations that the Bank of Canada (BoC) will maintain its elevated rates for three to four more quarters, before taking rates lower, says Royce Mendes, Desjardins’ managing director and head of macro strategy.

The 4.25-per-cent policy rate, which could jump to at least 4.5 per cent at next week’s BoC meeting, is “not sustainable over a long period of time,” he explains.

But here’s where it gets interesting.

Fixed-mortgage rates roughly track government bond yields over time. “The five-year rate is a reflection of the average BoC rate expected over a five-year horizon,” Mr. Mendes says, plus a small risk premium to compensate investors for committing capital long-term.

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Similarly, the one-year rate reflects the average expected BoC rate over the next 12 months.

If you believe, however, that markets are the best predictor of future rates – and despite being regularly wrong, they are indeed the best we’ve got, Mr. Mendes says – then “there really should be no way to arbitrage the path for interest rates.”

In other words, “It would be hard for households to have an edge against market pricing when predicting future rates,” he says.

Okay, so if rates are largely efficient, does it even matter what mortgage term people pick?

“That’s where we run into problems – where theory doesn’t reflect reality,” Mr. Mendes says.

Widely-cited research from York University’s Moshe Milevsky found that choosing a variable mortgage paid off about four out of five times historically, he says. One-year mortgages have a roughly similar edge.

But floating or going short-term may offer less upside today than it would have 20 years ago, simply because there was a lot more room back then for rates to fall, notes Mr. Mendes.

Albeit, the strategy is not completely invalid, he says. There’s still room for rates to fall given they’re arguably close to a cycle peak and given they should land about 2 per cent above the Bank of Canada’s long-term “neutral rate.”

The neutral rate is the theoretical policy rate that neither stimulates nor slows the economy and keeps inflation at the 2-per-cent target. The BoC thinks neutral lies somewhere between 2 and 3 per cent.

Does past rate research still apply?

“I haven’t seen anything to fundamentally change the equation since the study, and the equation is that variable rate does better because you’re not paying for a guaranteed rate,” Mr. Milevsky says. Essentially, you’re getting paid to assume the lender’s rate risk.

Yes, five-year fixed mortgages have materially lower rates right now, but that’s largely because Bank of Canada rate cuts are just starting to be priced into five-year terms. Barring another unforeseen inflation spike, variable and short-term rates will ultimately fall below five-year fixed rates, potentially by next year.

Regardless of expectations, the market compensates borrowers for taking risk. Over a five-year span, the risk-reward of taking back-to-back one-year fixed mortgages remains favourable. The fact that today’s one-year rates are so much higher doesn’t change that.

Mr. Milevsky cautions borrowers to consider more than just the odds, however.

For example, there’s a sufficient chance that homes might be worth less next year, he says. If so, that could prevent some borrowers from having enough equity to qualify at a new lender. In turn, they could be stuck with higher renewal rates from their existing lender.

Alternatively, someone who just bought an expensive, heavily leveraged home with modest savings might be wiser to lock in at least a portion of their borrowing, he says.

As for what mortgage Mr. Milevksy would choose right now, if you ask him he’ll rightly note that everyone’s personal balance sheet is different.

“I’m floating,” he says. “At no point would I lock in, because I can withstand the risk. On average, I think that I will be paying less and I can afford to focus on averages. Many people can’t.”

Rates this week

Lowest nationally available mortgage rates

TermUninsuredProviderInsuredProvider
1-year fixed5.74%Ratehub4.64%QuestMortgage
2-year fixed5.64%Ratehub4.64%QuestMortgage
3-year fixed5.24%Ratehub4.59%QuestMortgage
4-year fixed5.19%Ratehub4.64%QuestMortgage
5-year fixed5.09%HSBC4.54%Ratehub
10-year fixed5.94%HSBC5.54%Nesto
Variable5.90%Ratehub5.25%Nesto
5-year hybrid5.57%HSBC5.94%Scotia eHOME
HELOC *6.45%HSBCn/an/a

Source: Robert McLister; data as of Jan. 19

* Home equity line of credit

Rates are as of Jan. 19, 2023 from providers that advertise rates online and lend in at least nine provinces. Insured rates apply to those buying with less than a 20 per cent down payment, or those switching a pre-existing insured mortgage to a new lender. Uninsured rates apply to refinances and purchases over $1-million and may include applicable lender rate premiums. For providers whose rates vary by province, their highest rate is shown.


Robert McLister is an interest rate analyst, mortgage strategist and editor of MortgageLogic.news. You can follow him on Twitter at @RobMcLister.