Is it time to switch to a fixed mortgage rate?

Written by
Penelope Graham

Mortgage borrowers have struggled this year.

While Canada’s central bank has raised its key interest rate four times since March, the benchmark cost of borrowing has risen from 0.25% to 2.5%. This sent variable mortgage rates boiling over from the lows of below 2% that consumers have enjoyed for the past two years to over 4% today.

Meanwhile, fixed rate borrowers haven’t had it any easier. Bond yields – the metric lenders use when setting the pricing for their fixed-rate products – have hit record highs in recent months, on growing recession fears among investors. This pushed the five-year fixed options of the major Canadian banks to 6.14% in July.

But now there seems to be light at the end of the tunnel. As the most recent readings suggest inflation has peaked, it seems more likely that the Bank of Canada is nearing the end of its rate hike mandate – albeit another 0.75 to 1% hike is practically scheduled before it is completed.

The bond market is also taking a breather, with yields moderating from their peak of 3.5% in June. This lead to some discount among mortgage lenders with the major banks now all within the 5.2% range for a fixed period of five years.

READ: Lower fixed rates could be on the way as bond yields fall

This is less than what clients have seen for some time and, given that there is still expected upward movement on the variable side and the narrowing of the spread between the two types of rates, borrowers may ask themselves: is it now time to lock down?

The answer, according to Rob McLister, mortgage analyst at Mortgagelogic.newsis a resounding Nope.

“Nobody should be fixed at 100% for the long term anymore. This is a strategy for the bottom of a rate cycle,” he told STOREYS.

According to McLister, even if the gap between the fixed and the variable is narrowing, it matters less than one might think. What borrowers should consider is where we are in the current rate cycle.

“As we approach the peak of [the] rate, the cyclical nature of interest rates is starting to matter a lot more than the difference between fixed and variable,” he says. “There will come a time when variable rates will be significantly higher than five-year fixed rates and despite this, variable rates will have a much higher probability of success. Why? Because rates come back after hiking cycles. Historically speaking, the variable almost always prevails over a five-year period when the prime rate is 50% above its five-year moving average. We will be there next month when the BoC increases another more than 50 basis points.

Although he points out that there are expectations of the 50% rule – borrowers would have been “very sorry” to have a floating rate between 1978 and 1982, for example – there are strong chances that variable rates will remain the most affordable option over the next five years, especially as the BoC manages to control inflation.

“It can be a bumpy road for rates over the next 12-24 months, but what matters is your weighted average rate. It doesn’t matter if variable rates continue to rise the following year if your variable rate weighted average is better than a fixed rate for the rest of your term,” adds McLister.

The bottom line: Selecting a rate comes down to risk tolerance. For financially secure homeowners who can absorb higher or lower monthly payments for their principal debt for a temporary period, variable continues to be their best bet. For those who are more risk averse, McLister says, a hybrid rate could be the answer.

“Lock in the portion you feel comfortable with in a fixed rate,” he says. “That way you have more peace of mind, budget visibility, and you still retain some of a variable’s interest-saving potential.”

In a previous interview with STOREYS, Leah Zlatkin, Licensed Mortgage Broker and LowestRates.ca expert, said that while fixed rates provide temporary shelter from a fluctuating market, she actually views them as a higher risk product because of their limitations.

“I don’t like differential interest rate penalties, and I think for many Canadians flexibility is key, especially as we’ve seen over the last five years everything changes overnight,” says -she. “People like to be flexible and fixed rate mortgages lock you in.”

“Certainly, there are consumers who want to do that, and when the risks are explained to them, they still want fixed rate products because they would rather prevent than cure later. The challenge is that two years from now, if variable rates come back down, it’s those same customers who are going to call and say, “Why did you let me go with a fixed rate product that’s now two points higher than the market?

Written by
Penelope Graham

Penelope Graham is the editor of STOREYS. She has over a decade of experience in real estate, mortgages and personal finance. His commentary on the housing market is featured frequently in national and local media, including BNN Bloomberg, CBC, The Toronto Star, National Post and The Globe and Mail.

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