With the Bank of Canada widely expected to announce another outsized rate increase next week, a growing number of variable-rate mortgage holders ask themselves a dreaded question: Is it time to lock into a fixed rate?
The answer usually boils down to the state of the homeowners’ household finances, said James Laird, co-CEO of online rate comparisons side Ratehub.ca and president of mortgage brokerage CanWise Financial.
Borrowers who worry at all about their ability to absorb further mortgage rate increases should “seriously consider” switching to a fixed rate, he said. For those who still have plenty of wiggle room in their budget, it’s a matter of choosing the option they believe will ultimately save them money, Mr. Laird added.
Should interest rates come down in late 2023 and 2024, assuming inflation pressures ease amid a now-widely expected recession, sticking with a variable mortgage rate could still be “the right strategy,” he said.
For now, though, anyone with a variable rate should brace for more pain. The Bank of Canada has already increased its trend-setting interest rate to 3.25 per cent, up from 0.25 per cent at the beginning of March. And as it continues to battle inflation, the central bank is expected to announce another half-a-percentage point increase on Oct. 26, with more hikes likely in December and early 2023.
Some projections see the Bank of Canada rate climbing as high as 4.5 per cent next year.
When the central bank’s key rate changes, banks usually adjust their own prime rates, the benchmarks to which variable rates are pegged. For every quarter of a percentage point increase in the Bank of Canada rate, a homeowner with a variable mortgage rate and fluctuating payments can expect to pay around $14 more a month for every $100,000 worth of outstanding mortgage, according to Victor Tran, a mortgage and real estate expert at Ratesdotca, a financial products comparison site.
For recent homebuyers who haven’t made much of a dent in their principal balance and Canadians with large mortgages, the pain from those rapid rate increases has been especially sharp.
For example, a homeowner with a mortgage balance of around $380,000 – roughly the average borrowed by first-time homebuyers over the past couple of years – would have seen their monthly payments increase by more than $600 since March. If the Bank of Canada rate rose to 4.5 per cent, that borrower would end up with a payment approximately $900 higher than what they signed up for.
And while the vast majority of variable-rate holders have loans that would normally keep payments the same even if interest rates rise moderately, that feature no longer guarantees peace of mind in current market conditions.
The recent slate of interest rate hikes means variable-rate mortgages are starting to hit their so-called “trigger rate” – the rate at which the monthly payment no longer covers the interest owed. Borrowers approaching their trigger are typically in for bigger payments unless they’re able to make lump-sum payments toward their principal.
But switching to a fixed mortgage rate comes at a steep cost amid record high mortgage rates.
Variable-rate holders who lock in typically won’t have access to their lender’s most competitive rates, which are reserved for new customers, Mr. Tran warned.
Borrowers will also have to lock in for a period equal or greater to what’s left on their mortgage term, he added. In other words, a homeowner with a five-year variable and three years left before renewal would have to sign up for a fixed-rate mortgage of at least three years.
Those who’d rather lock in for a shorter term in case rates start to decline before too long would have to break their mortgage and pay a penalty. The fee is usually equal to three months’ worth of interest applied to the remaining principal balance.
Switching to a rival lender offering lower fixed rates also entails breaking your mortgage.
But an even bigger obstacle to deal-hunting on fixed-rate mortgages for many of today’s variable-rate mortgage holders comes from having to requalify for the mortgage stress test. For those who switch lenders, the test requires federally regulated lenders to verify that a new borrower would be able to keep up with their payments at the higher of 5.25 per cent or a rate two percentage point higher than the offered contract rate.
With current five-year fixed rates often above 5 per cent, borrowers hoping to lock in could easily face a qualifying stress test rate above 7 per cent, a high bar to clear for many homeowners, Mr. Laird noted.
Mr. Tran said the majority of his variable-rate clients, who are mostly high-net-worth clients with stable incomes, are staying put for now.
Still, anyone who’s wondering whether they should lock in should seek professional guidance, said Frances Hinojosa, a mortgage broker and co-founder and CEO of Tribe Financial Group.
“If you’re asking that question, it’s time to have a conversation with a mortgage professional to look at your options.”
If you have a variable mortgage rate with fixed payments, you can estimate your own trigger rate with the calculator below.