If you believe what the financial markets are telling us, today’s lowest variable mortgage rates will more than double in the next few years.
If that happens, that means the best variable rates for an uninsured mortgage would drop from around 1.34% today to around 3.09% three years from now, assuming lenders maintain similar profit margins and that the Bank of Canada increases interest rates as much as expected.
If that’s all that rates hike through 2024, you’ll end up with variable rate mortgages about 60 basis points higher than today’s best uninsured five-year fixed rates. (There are 100 basis points in a percentage point.)
Bank of Canada just gave mortgage buyers a good reason to freeze a rate
Of course, a lot will change between now and 2024. By then we will know how dangerous inflation was or was not. And we will know how aggressively the Bank of Canada had to raise rates to bring inflation back to its 2% target.
Unfortunately, scientists are still solving the problems associated with time travel. We will therefore have to rely on what we know today to assess the interest rate risk that borrowers will face over the next few years.
What we know today is that rates have stopped falling, at least materially and sustainably for the foreseeable future. The interest rate cycle is firmly on the rise given the increased risk that the Bank of Canada will lose its battle against inflation over the next 12 months.
Since the dawn of modern monetary policy in the 1990s, past rate hike cycles have resulted in policy rate jumps of 75 to 275 basis points. Yields on five-year government bonds – which lead to fixed mortgage rates – rose 125 to 200 basis points.
Using this history as a very rough guide, and let me stress ‘rough’, one would expect that hotter and more persistent inflation than expected could theoretically push floating rates up by 275 basis points. and five-year fixed rates of 200 basis points – or more. Let’s call this the “near worst case” scenario.
This scenario would result in an increase of approximately $ 400 in the monthly payment on a typical variable rate mortgage. This is based on the national average mortgage balance of about $ 304,772, according to the latest data from TransUnion, and remaining amortization of about 19 years, which roughly matches the Canadian average.
If this scenario were to unfold over the next three years, the current best fixed rate of 2.49% over five years would save the typical borrower nearly $ 10,000 in interest over five years compared to what is today a variable of 1.34%.
If rates only increased a little more than half, or 150 basis points – which is about the average for a rate hike cycle in Canada – then the best fixed and variable rates in Canada. today would eventually break even. This does not involve any prepayment penalty.
So if you choose a variable for the big upfront interest savings, you are probably expecting the Bank of Canada to grow five times or less. With average core inflation nearing three-decade highs, is this really a bet you want to make? Only you can answer this question, and only after careful consideration of your ability to handle the “worst case” scenario.
Variable rate spread widens
Fixed mortgage rates have risen steadily over the past five weeks. Rising bond yields have forced five-year fixed rates to rise 40 basis points or more since late September.
Meanwhile, variable rates on new mortgages have changed little, as they are largely dependent on the prime rate. Premiums will not start to increase until at least before the first quarter of 2022, based on implicit bond market rates.
This divergence widened the gap between the best fixed and variable rates to 115bp, the largest in a decade.
Historically, this wide spread pushes people towards variables, which would never have considered a variable before. But it is essential to quantify your risk, given your:
- Five year plan – will you need a mortgage for a few years, for example? If so, a long-term fixed contract could cost you higher interest and breakage fees.
- Financial cushion – will your budget withstand an increase in payments of several hundred dollars per month?
- Mental toughness – will reading the Bank of Canada rate hikes repeatedly make you nervous?
The price of fixed rate “insurance” in the mortgage market is about 100 basis points higher than it was a year ago, but depending on your situation and the answers above, it can still be. be a premium worth paying.
The rates shown in the table are from providers who lend in at least nine provinces and advertise the rates on their websites. Insured rates apply to those who buy with less than 20% down payment or to those who transfer a pre-existing insured mortgage to a new lender. Uninsured rates apply to refinances and purchases over $ 1 million and may include rate premiums applicable to lenders.
Robert McLister is an Interest Rate Analyst, Mortgage Planner and Associate Editor for The Globe and Mail. You can follow him on Twitter at @RobMcLister.
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