The recent interest rate hikes by the Bank of Canada may have some variable rate mortgage holders wanting to convert their variable mortgages and lock into a fixed rate mortgage.
It’s understandable why homeowners are considering switching, given the high inflation and the uncertainty in our World. But is it necessary to make the switch right now?
Rates can go 1 of 3 ways, up, down or stay the same. Most importantly, ensure you’re not making any decision out of fear.
The pandemic has been interesting when reviewing the economic impact of it.
When Canada was forced to shelter in place during various lockdowns our economy slowed and our governments reacted with massive social and economic spending programs to help provide stability.
At the start of the pandemic, the Bank of Canada dropped its already-low key policy interest rate to .25% to encourage consumer borrowing and stimulate the economy. Banks responded by setting their mortgage rates to historic lows.
At the time there wasn’t a significant spread between fixed-rate and variable mortgages. But that difference grew over the past two years. Currently, there is about a 1.5% difference.
Variable rates can only go up after being set to record lows in 2020. Those with a fixed rate mortgage are guaranteed the same rate for their borrowing term which is typically 5 years for most Canadians.
That said, it’s important to note that variable mortgages have historically won the race when it comes to paying off their principal faster. This was still the case before the pandemic started.
With that in mind, here are some ideas variable mortgage holders can do to help navigate what’s ahead.
Keep Calm
On April 13, 2022, the Bank of Canada increased the overnight rate by .5% to 1%. It’s the second hike this year and the biggest in 20 years. This is the highest borrowing rates since the pandemic started.
The Bank of Canada is expected keep increasing rates thanks to soaring inflation and other global instability.
Variable mortgage holders might be worried about affording a change in their rates, which currently sit around 2.7%, depending on the lender and when the mortgage was funded.
Since 2017 every mortgage has been stress tested, meaning consumers must qualify for their mortgage assuming rates were much higher than they are. Currently the stress test is 5.25% or the advertised rate plus 2% whichever gets to at least 5.25% or the higher amount.
Budget & Pre Pay The Spread
I suggest all my clients take the variable rate mortgage, but budget themselves as if they were paying a fixed rate mortgage (1.5% higher). By budgeting this way, not only will you budget for future interest rate hikes before they happen, you’ll hammer down your principal in the process if you direct the money towards the mortgage.
Still considering on switching to a fixed rate?
If you’re still leaning toward a fixed rate, I would suggest looking elsewhere than Canada’s Big 5 banks.
Those mortgage products come with massive penalties if you break your mortgage early for any reason. Canadians break mortgages for many reasons, life happens… divorce, refinancing to pay off high interest debt, major home renovations, new additions to the family, moving to take a new career/ promotion and other life events.
Recently I had a client break a 5-year fixed mortgage and the penalty was just over $40,000! Had that individual held a variable mortgage the penalty would have been approximately $5,500. Variable rate penalties are only three months interest, VS. fixed penalties are about 4.5% of the mortgage balance. On average, 2/3 homeowners in Canada break mortgages around 36 months. Think twice before taking a 5-year fixed rate mortgage.
There are some options for those who still want a fixed rate mortgage, one being a monoline lender that is typically only available through a licensed mortgage agent/ broker. Monoline lenders, are not as aggressive on their penalties they charge clients when breaking a mortgage before the renewal date. Interested in learning more and how it pertains to your situation, then just give me call to discuss.