Canadians with variable rate mortgages will no doubt have noticed climbing payments over the past year. In 2018, the Bank of Canada raised its overnight lending rate three times, from 1% to 1.75%, leading to a jump in the prime rate of the big banks, which in turn passed those increases on to consumers in the form of higher mortgage interest payments.
Although the interest rate climb seems to have stopped for now, it naturally raises the question of whether consumers should consider switching to a fixed rate mortgage.
Let’s say you have a $1 million home with a $400,000 mortgage and a 3% variable rate mortgage. Your monthly payment, which is likely already up around the $2,000 mark depending on your amortization period, would now cost an extra $160 per month, factoring in the three rate increases last year. And if the BoC raises rates two more times in 2019, which admittedly appears unlikely, then you’ll end up paying an additional $260 per month on top of the 2018 increases.
Most studies have shown that in the long term, you are better off with a variable rate mortgage. However, rising rates can put pressure on a household’s cash flows, especially in Toronto and Vancouver, where housing costs have reached record highs, though they have started to fade a bit this year, particularly in Vancouver where the average composite benchmark price for a home was $1,011,200 in March 2019, down nearly 8% from the same month last year.
Fixed v Variable
The decision regarding fixed versus variable rate mortgage often comes down to something basic – like the homeowner’s appetite for risk. Some people take comfort in knowing their mortgage payment will remain the same every month for the next five years, no matter what happens at the Bank of Canada or in the Canadian bond market. Others can sleep well knowing they will reap the savings if interest rates go down, and don’t worry much about potential rate increases.
Let’s say you’re in a variable rate mortgage rate but have decided to switch to a fixed rate, what happens then? In most cases, the change will require you to break your current mortgage, which comes with a cost. Some borrowers could end up paying an additional three months in mortgage rate interest. However, not all lenders apply this penalty. Some companies, including IG Wealth Management, will waive any fees for borrowers looking to switch from a variable rate mortgage to a fixed rate mortgage of equal or longer term.
And depending on how much time you have left on your variable mortgage, it may or may not be worth doing. If you are in Year 4 or 5, it’s likely easier to wait until the mortgage ends then renew with your preferred product. But, if you are in Year 1 or 2 of your variable rate mortgage, switching to a fixed rate could save you a lot of money. Remember though that you are giving up any potential savings tied a decline in variable rates.
In the end, the decision to go fixed or variable is a personal one, based on a variety of factors. Working with a mortgage professional can help you map out the implications of each option in the context of your long-term financial goals. In addition, your financial consultant can help you work out how your mortgage fits in with your other debts and financial products. Look at the big picture and choose the best option to suit your needs.